Diluted EPS Calculation

Diluted earnings per share (EPS) is normally calculated with the following formula:

Diluted EPS = Net income – Dividends on preferred stock/ (Weighted average number of outstanding shares + Conversion of diluted securities)

In order to calculate the CDS, you have to take the number of convertible shares and multiply it by the conversion ratio, which is the ratio or percentage at which the convertible security can be converted to common stock.

Here's an very simplified example: A convertible bond's conversion ratio is 10. The bond's par value (amount listed on the face of the bond) is $10,000. The bond's conversion price is $1,000 ($10,000 / 10). This, plus the conversion prices of all other dilutive securities, should be the number you use for CDS. Sometimes the conversion ratio will be the interest rate on the bonds or some other type of percentage. For example, in order to calculate diluted EPS from 5% interest, you would have to multiply by 0.05. Conversion of diluted securities is basically showing investors what would happen if certain outstanding securities were converted into common stock. Such a conversion would affect the earnings per share (EPS) by diluting (lowering) the actual EPS.

This article shows how to find diluted EPS from a company's balance sheet. And this article gives a very detailed analysis of how diluted EPS is calculated on a company's balance sheet.