EPS, or earnings per share, measures the amount of earnings a company has for every common share outstanding. Some companies also offer preferred shares or other securities which, while not currently common shares, can be converted to common shares. The diluted EPS measures the earnings per share as if all the securities have been converted to common shares. To accurately calculate the diluted EPS, you must add back the special costs associated the other convertible securities, such as preferred share dividends paid.
1. Calculate the total number of securities that could be converted to common shares. For example, if the company has 50,000 preferred shares that could be converted for two shares of common stock each, the company would have 100,000 potential common shares.
2. Add the number of potential common shares to the current common shares outstanding to find the adjusted shares outstanding. In this example, if the company has 270,000 common shares outstanding, add 100,000 potential shares to 270,000 existing shares to get 370,000 adjusted shares outstanding.
3. Add the amount of preferred dividends paid to the company's earnings. You add back the preferred dividends because if the shares were converted to common shares, the company would not have to pay those preferred dividends. In this example, if the company paid $25,000 in preferred share dividends and had earnings of $500,000, add $25,000 to $500,000 to get $525,000.
4. Divide the adjusted earnings by the adjusted shares outstanding to find the company's diluted EPS. Completing this example, divide $525,000 by 370,000 to find the company's diluted EPS equals $1.42.
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