Diluted and basic earnings can differ based on the number of shares outstanding used in their calculations.
The term diluted shares outstanding accounts for any financial instrument that may be converted into company stock in the future – stock options, warrants, convertible stock, etc. The diluted share method shows a more conservative figure than basic shares outstanding, which reflects all shares actually registered and potentially available for purchase at the close of a quarter.
When most companies release earnings and report the results to the SEC, two entries will appear on the income statement: basic earnings per share and diluted earnings per share. To arrive at these figures, net income is simply divided by both basic shares outstanding and diluted shares outstanding. The diluted share count is most often used by analysts because it reflects all stock that could potentially be out in the marketplace.
There shouldn’t be too large of a discrepancy between basic and diluted shares. If there is, it could be a sign of caution that future share dilution could limit a stock’s upward price movement. Remember, any company that issues a lot of stock options will likely continue to do so, diluting future results as well. In addition, the diluted figure becomes particularly important when a company is acquired, because any outstanding convertible instruments are usually subject to immediate redemption.
So, whenever you do your own analysis, use the diluted number – it’s the most conservative gauge.