Layman guide for EPS and Diluted EPS- stock investing guide

EPS:(Earning per share)

By definition, EPS is net income divided by the number of shares outstanding at the specified date of balance sheet.

Diluted EPS:

Many companies are issuing FCCB(Foreign currency convertible bonds)/debentures to selected investors in order to raise money overseas or inside the country. The conversion of bond to equity is assured at lower rates at a future specified date. Due to issue of equity at lower price, the coupon rate(interest rate) will be very nominal. Thus company is taking advantage in getting funds at cheaper cost but it costs higher for ordinary equity holder of the company. So seeing only EPS will not do but investors should look into diluted EPS also in order to know the value of equity share. ESOPs, Warrants etc. are other instruments in this category.

Thus diluted EPS  is an additional ratio used to gauge the quality of a company’s earnings per  share (EPS) if all convertible securities were exercised. Convertible securities  refers to all outstanding convertible preferred shares/ convertible debentures and  stock options (primarily employee based). It should be noted that  earnings per share is calculated by dividing the  company’s profit by the number of shares outstanding. Warrants, stock  options, convertible preferred shares, etc. all serve to increasing the number  of shares outstanding.  If the  denominator in the equation (shares outstanding) is larger,  the earnings per share is reduced (the same profit figure is used in the  numerator). Normally all conversions are at a rate lower than market rate of share and hence EPS is getting diluted due to increase in number of shares and difference in market rate and conversion rate is enjoyed by the new shareholders.  The only loss to new shareholders will be the interest or dividend etc which they will have to forego which will be beneficial to all shareholders as this will add up to income . If conversion is compulsory as per terms irrespective of market price of the share, then existing shareholders will be benefited if the market price is lower than conversion price. This is one of the important ratio while deciding to invest in shares.

For example:  One company X is having net income of Rs.20 crores and one crore weighted average no. of shares are outstanding as on particular  date. FCCB/debentures worth Rs. 50 lakhs which are waiting to be converted to equity shares of rs. 10 each with a premium of Rs.40. Till conversion, FCCB/debentures carry interest @12%. Tax rate say 30%. The market rate of the share is Rs.100. Calculate EPS and diluted EPS.

EPS:  20 crores/1 crore = 20

Diluted EPS: If all the FCCB/Debentures converted into shares on stipulated date of conversion, then additional shares added to existing equity shares will be 100000. (50,00,000/50). So the total shares likely to be outstanding will be one crore and one lakh shares.(WASO).WASO means weighted average shares outstanding. When the shares are converted, then there is no need for payment of interest of 12% on amount of Rs. fifty lakhs worth FCCB/Debentures. The interest outgo saved will be 6 lakhs and this will be added to income before taxation . Interest is tax deductible and if this amount becomes income, then the company has to pay tax.  Applying 30% tax rate on this amount, 600000(1-30%)=Rs.420000 .This can be added to net income for calculation of diluted EPS which will be 20,04,20,000/10100000=19.84.  From this, we can understand that the EPS of shareholder reduced from 20 to 19.84.

Some of the companies EPS and Diluted EPS are given below ( taken from Economic times of india)

Gati       1.7     1.2

Subex   12.5   8.6

Orchid chemicals 22.2   18.3

IFCI        10.1     8.7

Kasturi global  2.9   2.4

Rei Agro     3.5   3.1

ICSA (india)  26.4   23.5

So investors should take note of diluted EPS only for their calculation for the long term.


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