Understanding the Differences: Basic EPS vs. Diluted EPS (GAAP) vs. Adjusted Diluted EPS (Non-GAAP)
EPS (Earnings per Share): A Beginner’s Guide
EPS, or earnings per share, is a key metric used by investors and analysts to evaluate a company’s financial performance. However, not all EPS calculations are created equal. In accounting, there is a set of standards known as Generally Accepted Accounting Principles (GAAP) which are used to ensure that financial statements are consistent and transparent. In this blog post, we’ll take a deep dive into the different types of EPS calculations and explore the key differences between basic EPS (GAAP), diluted EPS (GAAP), and adjusted diluted EPS (non-GAAP).
Basic EPS (GAAP)
The primary use of basic EPS is to provide a basic measure of a company’s earnings performance by showing how much profit is generated per outstanding share of common stock. One of the advantages of using basic EPS is that it is a straightforward measure of a company’s earnings performance. It is also useful for comparing the earnings performance of different companies or for comparing a company’s performance over time.
Basic EPS (GAAP) is calculated by dividing a company’s net income by the number of outstanding shares. It is the most basic and straightforward EPS calculation. The formula for Basic EPS (GAAP) is as follows:
(Net Income – Preferred Dividends) / Weighted Average of Outstanding Shares
For example, if a company has a net income of $1 million, 1 million outstanding shares, and $100,000 preferred dividends, the Basic EPS (GAAP) would be $0.90.
| Net Income | Preferred Dividend | Outstanding Shares | Basic EPS |
|---|---|---|---|
| $1,000,000 | $100,000 | $1,000,000 | ($1,000,000 – $100,000) / 1,000,000 = $0.90 |
Diluted EPS (GAAP)
Diluted EPS (GAAP) takes into account the potential dilution of a company’s earnings from dilutive securities such as options and convertible bonds. This method is used to provide a more conservative estimate of EPS and to reflect the potential dilution of existing shareholders’ ownership.
The diluted shares are calculated using the if-converted method. The “if-converted” method is used to calculate diluted EPS (GAAP) by assuming that all potential dilutive securities, such as convertible bonds or options, are converted into shares of common stock. The formula for diluted EPS (GAAP) is as follows:
(Net Income – Preferred Dividends) / (Weighted Average of Outstanding Shares + Diluted Shares)
For example, if a company has a net income of $1 million, 1 million outstanding shares, $100,000 preferred dividends, and 500,000 options that could be exercised at $20 per share, the diluted EPS (GAAP) would be $0.88.
| Net Income | Preferred Dividend | Outstanding Shares | Diluted Shares | Diluted EPS |
|---|---|---|---|---|
| $1,000,000 | $100,000 | $1,000,000 | 500,000 / $20 = 25,000 | ($1,000,000 – $100,000) / (1,000,000 + 25,000) = $0.88 |
Adjusted Diluted EPS (Non-GAAP)
Adjusted diluted EPS (Non-GAAP) is a variation of diluted EPS (GAAP) that excludes certain non-recurring or non-operating items from the net income calculation. Examples of non-recurring or non-operating items include:
- One-time gains or losses, such as the sale of a business or a significant asset
- Restructuring charges, such as costs associated with closing a facility or laying off employees
- Impairment charges, such as the write-down of an asset’s value
- Legal or regulatory settlements or judgments
- Foreign currency translation gains or losses
- Gains or losses from the sale of investments or other securities
- Natural disasters or other unusual events that have a significant impact on the company’s financial performance
The purpose of adjusted diluted EPS (non-GAAP) is to give a more accurate picture of a company’s underlying earnings performance by removing the impact of one-time events. However, it is important to note that non-GAAP financial measures are not recognized by GAAP and may not be comparable to other companies’ non-GAAP measures.
The formula for adjusted diluted EPS (Non-GAAP) is as follows:
(Net Income +or- Non-Recurring or Non-Operating Items) / (Weighted Average of Outstanding Shares + Diluted Shares)
For example, if a company has a net income of $1 million, 1 million outstanding shares, $100,000 preferred dividends, 500,000 options that could be exercised at $20 per share, and $50,000 in non-recurring items, the adjusted diluted EPS (non-GAAP) would be $0.83.
| Net Income | Preferred Dividend | Non-Recurring Item | Outstanding Shares | Diluted Shares | Diluted EPS |
|---|---|---|---|---|---|
| $1,000,000 | $100,000 | $50,000 | $1,000,000 | 500,000 / $20 = 25,000 | ($1,000,000 – $100,000 – $50,000) / (1,000,000 + [500,000 / 20]) = $0.83 |
Example of Diluted EPS (GAAP) and Adjusted EPS (Non-GAAP) in Microsoft FY23 Q2 Earnings Release Report
EPS (Earnings per Share): Making Sense of the Numbers
In conclusion, understanding the different types of EPS calculations is crucial for investors and analysts looking to evaluate a company’s financial performance. basic EPS (GAAP) is the most basic and straightforward calculation, while diluted EPS (GAAP) takes into account the potential dilution of a company’s earnings from dilutive securities. Adjusted diluted EPS (Non-GAAP) is a variation of diluted EPS that excludes certain non-recurring or non-operating items from the net income calculation. Keep in mind EPS is just one piece of the puzzle when it comes to evaluating a company’s worth, but it’s an important one that should not be overlooked.
