How to Calculate Dilution in Earnings Per Share

by Edriaan Koening

As an investor, you use various tools to determine whether to invest in a particular company's stocks. Earnings per share calculates a company's total earnings for a period of time and divides it by the number of shares outstanding. This helps you measure the financial health of the company. The number of shares outstanding may increase over time and reduce the company's earnings per share. Known as dilution, this process may reduce the value of individual stocks.

Find out the number of shares outstanding for the period you are analyzing. The value of the shares don't affect the earnings per share calculation. For example, a company may have 500,000 shares outstanding, each worth $10. It does not matter if each share is worth $15 or $20 instead of $10.

Check the amount of earnings the company generates during the period. You may find this information in the company's income statement.

Divide the company's earnings by the number of shares it has outstanding to get the earnings per share. For example, the company may earn $1 million with 500,000 shares outstanding. Its earnings per share would be $2 (from $1 million / 500,000).

Determine the number of stock options, warrants and other convertible securities the company has outstanding. An investor who holds such securities can convert them into stocks, increasing the number of stocks outstanding. Diluted earnings per share figure assumes that investors convert all these securities into stocks.

Divide the company's earnings by the number of shares outstanding if investors turn all convertible securities into stocks. For example, a company gets $1 million in earnings and has 250,000 stock options in circulation with 500,000 stocks already outstanding. Its diluted earnings per share would be $1.33 (from $1 million / 750,000). Compare this with the higher, undiluted earnings per share of $2 in Step 3.

Photo Credits

  • Comstock/Comstock/Getty Images