Diluted EPS is earnings per share calculated as if all possible sources of new shares were converted into actual shares. These sources include employee stock options, warrants, and convertible bonds. Diluted EPS is typically lower than basic EPS because it spreads the same earnings across more shares.
A company has $50 million in earnings and 10 million basic shares outstanding, giving basic EPS of $5. However, if all employee stock options and convertible securities were exercised, there would be 12 million shares. The diluted EPS would be $4.17, showing a more conservative view of earnings per share.
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