Diluted earnings per share (diluted EPS) is a measure of the profit attributable to each ordinary share that would be paid if all convertible securities and options were exercised. It is calculated using the following formula:
Profit / (Number of ordinary shares + Convertible securities + Options)
For example, assume a company has 100,000 outstanding ordinary shares, 10,000 convertible bonds, and 5,000 options. The diluted EPS would be calculated as follows:
Profit / (100,000 + 10,000 + 5,000) = diluted EPS
The diluted EPS may be less than the basic EPS if the conversion price of the convertible securities or options is below the market price of the underlying shares. In this case, the conversion would have a dilutive effect on earnings per share.