Why can negative earnings per share (EPS) be misleading?
Recently, I was discussing anti-dilutive effects on a student’s financial model. This problem arises for companies that have negative EPS. EPS is defined as Net Income to Common/Shares Outstanding. Because companies cannot have a negative amount of shares outstanding, the only way to have negative EPS is by operating at a net loss (negative net income).
The point of confusion exists within the share count calculation. There are two ways to determine shares outstanding, the shares of common equity and the fully diluted share count (includes the effects of any dilutive securities).
Holding the numerator, net income, constant and increasing the denominator results in EPS falling when net income is positive. However, when net income is negative, increasing the denominator increases the earnings per share (making it less negative as losses are allocated amongst more shares). EPS should NOT increase with dilution because existing shareholders own a smaller percent of the company.
Therefore, when companies operate at a negative net income and have dilutive securities, they report basic and diluted EPS as the same value, determined by the number of common shares outstanding.
In the example below, if you have -$100 Net Income, 100 basic shares, and 200 diluted shares, then the basic EPS is -$1 and the diluted EPS is -$0.50. But this would indicate an improvement from dilution, which is inaccurate. As a result, we use basic share count under both cases to arrive at -$1 EPS.
If we take a look at Coursera’s SEC filings in their most recent quarter, we can see that they operated at a net loss of -$32mm Q3’23.
As a result, if management were to calculate diluted EPS based on diluted shares outstanding, this would be anti-dilutive, making it look as if issuing more shares increased the value of the company, inaccurate.
So, management makes the following note.
“The following potentially dilutive securities were excluded from the computation of diluted net loss per share calculations for the periods presented because the impact of including them would have been anti-dilutive”
