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Financial Ratios - Dilutive Securities

Filed Under Investing Basics, Investment, Mutual Funds, Personal Finance, Portfolio Management, Stocks Dilutive Securities are securities that are not common stock in form, but allow the owner to obtain common stock upon exercise of an option or a conversion privilege. The most common examples of dilutive securities are: stock options, warrants, convertible debt and convertible preferred stock. These securities would decrease EPS if exercised or if they were converted common stock. In other words, a dilutive security is any securities that could increase the weighted number of shares outstanding. If a security after conversion causes the EPS figure to increase rather than decrease, such a security is an anti-dilutive security, and it should be excluded from the computation of the dilutive EPS. For example, assume that the company XYZ has a convertible bond issue: 100 bonds, $1,000 par value, yielding 10%, issued at par for the total of $100,000. Each bond can be converted into 50 shares of the common stock. The tax rate is 30%. XYZ's weighted average number of shares, used to compute basic EPS, is 10,000. XYZ reported an NI of $12,000, and paid preferred dividends of $2,000. What is the basic EPS? What is the diluted EPS? 1) Compute basic EPS: i. Basic EPS = (12,000 - 2,000) / (10,000) = $1.00 2) Compute diluted EPS: i. Find the adjustment to the denominator: 100 * 50 = 5,000 ii. Find the adjustment to the numerator: 100 * $1000 * 0.1 * (1 - 0.3) = $7,000 3) Find diluted EPS: i. Diluted EPS = (12,000 - 2,000 + 7,000) / 10,000 + 5,000 = $1.13 If the fully dilused EPS > basic EPS, then the security is antidilutive. In this case, Basic EPS = $1.00 is less than the fully diluted ESP, and the security is antidilutive.

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28-07-2012 14:58