Which EPS?

One problem with using financial ratios is that the calculation of these numbers is done differently by different people. You would think that EPS would be calculated the same all over, but in fact there are two common EPS numbers, the basic EPS and the diluted EPS. The basic EPS is calculated as we have done in the textbook, that is, net income divided by shares outstanding. The diluted EPS is the net income divided by the total potential shares outstanding. Many companies use stock options to motivate employees, especially upper management. If there are a large number of employee stock options issued by the company and not yet exercised by employees the number of shares outstanding could grow rather quickly if the options are exercised. The diluted EPS uses the number of shares as if all employee stock options were exercised. This gives a lower EPS, which is a more conservative estimate of the company's EPS.