Fully Diluted Shares
Fully diluted shares outstanding represents a company's shares outstanding, adjusted for any stock options and/or potentially dilutive securities such as the equity component of convertible debt (which is debt that can be converted into equity under certain circumstances)[1][2].
Fully diluted shares contains not only those which are presently issued but those that may be claimed through conversion as well. The company needs this number of shares for their earning per share calculations because implementing fully diluted shares expands the share basis in the calculation while lowering the dollars earned per share of common stock[3]
The treasury stock method
The treasury stock method of accounting is used to calculate fully diluted shares outstanding for options and the if-converted method is used for convertible debt or preferred stock. In the treasury method, the options are assumed to have been exercised and the proceeds from the sale of shares are used to repurchase shares in the market at the current market price, thereby partially offsetting the number of new shares issued from the options. Similarly, the if-converted method assumes that potentially dilutive securities are converted to equity. Therefore, the number of shares outstanding increases, but the amount of debt or preferred equity on the balance sheets declines, as does interest expanse ( in the case of convertible bonds) or dividends paid ( in the case of preferred equity), reflecting the fact these securities no longer "exist" since they are assumed to have been converted into common equity.
Options:
- An option is a security that allows the owner to buy a share of common stock at some predetermined price. The predetermined price is called the strike price (also known as the exercise price)
Basic shares outstanding and fully diluted shares outstanding: Basic shares outstanding are the total number of shares issued and outstanding by a company. The issued and outstanding shares may be significantly fewer than the shares authorized in a company's charter or bylaws. Treasury shares ( shares that have been repurchased by the company in the open market) are considered issued, but they are not considered outstanding and, therefore, are not included in the calculation of shares outstanding.
Completely diluted shares are calculated by adding basic shares to additional shares that can be issued from options. To calculate the available cash based on the difference between the strike price and the current share price and to determine the number of additional shares that can be bought back for that cash
To calculate the effects of convertible securities for fully diluted shares outstanding using the if-converted method, you must determine if the convertible is in or out of the money. If it is in the money, then you would calculate the number of shares that would be issued if the convert were exercised. The steps to calculate the new shares issued for a convertible bond are as follows:
- Nominal value of bond issue/par value ( for bonds par value is usually $ 1.000, but not always)=number of bonds
- Issue Price x (I+ conversion premium) = conversion price (usually 20-40% premium, but not always)
- Par value (usually $1,000, but not always)/conversion price - conversion price = conversion ratio
- Par value (usually $1,000, but not always)/conversion ratio = conversion price
- Number of bonds x conversion ratio = number of new shares issued
- Conversion price < stock price then convert is "in the money’"
- If conversion price > stock price then convert is "out of the money"
- If conversion price is close to the stock price then convert is "at the money"
- One example of fully diluted shares is when a company's board of directors grants stock options to its employees. This can increase the total number of shares outstanding and therefore dilutes the value of the existing shares.
- Another example of fully diluted shares is when a company issues convertible bonds or other convertible securities to raise capital. These securities are exchangeable for shares of the company, and if they are converted, they will increase the total number of shares outstanding and dilute the value of existing shares.
- A third example of fully diluted shares is when a company issues additional shares to raise capital or pay off debt. This will also increase the total number of shares outstanding and dilute the value of existing shares.
Fully diluted shares outstanding provide a more accurate representation of the company’s stock situation and can help investors make more informed decisions. Here are some of the advantages of fully diluted shares:
- It allows investors to better assess the financial situation of the company by taking into account all outstanding shares and potential securities such as stock options and convertible debt.
- It gives investors a better understanding of the company’s financial position and potential future performance.
- By taking into account all outstanding shares and potential securities, investors are better able to gauge the true value of the company’s stock.
- It allows investors to accurately compare the performance of different companies in the same industry.
- It provides an accurate measure of a company’s shareholder base, which can help investors in making informed decisions.
Fully diluted shares outstanding is a metric that can be used to understand a company's potential equity ownership. However, it has some limitations that should be taken into consideration. These include:
- The complexity of the calculation, which can make it difficult to obtain an accurate assessment of the equity ownership.
- It does not take into account the potential dilution of any future share issuances that may occur, such as stock options or convertible debt.
- It does not account for any fractional shares that may be issued as a result of the conversion of convertible debt or stock options.
- It does not account for the potential dilution of existing shares, should the company issue additional shares.
- It does not consider the value of the shares, which can be affected by market conditions.
Fully Diluted Shares is a term used to describe the total number of shares a company has outstanding, when potential dilutive securities are taken into account. In addition to regular shares and stock options, other approaches related to Fully Diluted Shares include:
- Warrants: A warrant is a security that entitles the holder to buy a certain number of shares of the company at a predetermined price during a specified time period.
- Convertible Preferred Stock: Convertible Preferred Stock is a type of preferred stock that can be exchanged for a predetermined number of common stock shares at a certain price.
- Convertible Debt: Convertible debt is a type of loan agreement between a company and a lender that can be converted into equity at the discretion of the lender.
In summary, Fully Diluted Shares represent the total number of shares a company has outstanding, including all stock options, warrants, convertible preferred stock, and convertible debt.
| Fully Diluted Shares — recommended articles |
| Treasury Stock Method — Money-weighted rate of return — Annual Basis — WACC — Running yield — Net yield — Market value ratios — Yield on cost — Earnings Multiplier |
References
- Carver L. (2011), Venture Capital Valuation: Case Studies and Methodology, John Wiley & Sons, New Jersey
- Castillo J. (e.)(2006), The Recruiting Guide to Investment Banking, Circinus Business Press, United States of America
- Shenoy C.(e)(2008),Applied Portfolio Management: How University of Kansas Students Generate Alpha to Beat the Street, John Wiley & Sons, New Jersey
Footnotes
Author: Andżelika Kędzior
