Diluted Normalized Earnings Per Share: What It Is, How It Works

What Is Diluted Normalized Earnings Per Share?

Diluted normalized earnings per share shows a company's profit per share after stripping out one-off income or expenses and assuming all stock that could potentially be issued has been. The metric is calculated by taking profit (less one-time earnings) and dividing by the sum of outstanding common shares and potential outstanding shares.

Diluted normalized EPS differs from regular earnings per share (EPS), because it accounts for convertible securities and preferred stock, as well as stock options and warrants. This means dividing normalized profit by a larger number of shares, resulting in fewer earnings per share.

Understanding Diluted Normalized Earnings Per Share

EPS is one of the most important variables used to determine a company's profitability and value each of its individual shares. Several different versions of this metric are published in financial statements and brokerage research notes, though, so it is important that investors understand what each one represents.

Normalized earnings are profits that have been adjusted to exclude the effects of seasonality, irregular items such as non-recurring expenses, or one-time gains such as from the sale of a division. Adding dilution to this equation then assumes all convertible securities (investments that can be changed into common stock) have been exercised.

Including all of a company's potentially outstanding shares increases earnings dilution to shareholders by spreading a company's profit over a larger number of shares. As a result, while a company's diluted normalized EPS might occasionally be similar to its basic EPS, in cases where the company is large and established it will almost always be lower. 

Along with other measures of profitability, analysts and investors typically track a company's diluted EPS over time, comparing it against industry peers for valuation purposes.

Benefits of Diluted Normalized Earnings Per Share

Calculating diluted EPS figures based on normalized earnings, excluding one-time events, gives a truer picture of underlying profitability. This particular metric is often overlooked, despite providing a more conservative yardstick for analysis, valuation and investment comparisons than headline EPS, which is a company's earnings based solely on operational and capital investment activities.

Investors focus on diluted EPS because the number gives a clearer picture of a company's income. The more closely a company's diluted normalized EPS tracks its EPS figure, the more stable its profitability per share. The greater the difference, the greater the risk of share dilution and unsustainable ongoing operations.

Comparing the two numbers can alert analysts and investors to potential developments likely to result in lower-than-expected shareholder earnings and dividend payouts. Looking at diluted normalized EPS can also help pinpoint a company with a large number of convertible securities and large stock option issuance.