What are Fully Diluted Shares?
Fully diluted shares are the total number of common shares of a company that will be outstanding and available to trade on the open market after all possible sources of conversion, such as convertible bonds and employee stock options, are exercised. Fully diluted shares include not only those which are currently issued but also those that could be claimed through conversion. This number of shares is needed for a company’s earnings per share (EPS) calculations because applying fully diluted shares increases the share basis in the calculation while reducing the dollars earned per share of common stock.
Understanding Fully Diluted Shares
Fully diluted shares affect the EPS of a company, which is a common metric for assessing relative value and profitability. EPS representsnet income minus preferred dividends, divided by the weighted average of common shares outstanding, in which the weighted average of common shares outstanding =(beginning period balance + ending period balance) / 2.
If a company can increaseearnings per common share, it is considered to be more valuable and the publicly traded share price may increase. However, the number of outstanding shares affects this metric and, when the number increases, it reduces the EPS.
Key Takeaways
- While fulldilution may not occur all at once, it indicates how many shares might be outstanding in the future, based on current company policy regarding conversions.
- Earnings paid to preferred shareholders ascash dividends are subtracted from net income because EPSapplies only to common shareholders.
- Company policy regarding conversions may change over time, potentially impacting expectations about the future number of fully diluted shares.
Factoring in Fully Diluted Shares
Assumethat ABC Corporation (ABC) generates $10 million in net income and payspreferred shareholders a total of $2 million in dividends. The net income available tocommon shareholders is $8 million. If the firm’s weighted average of common shares outstanding totals 1 million, the EPS will be $8.00 per share or ($8 million / 1 million shares). This $8.00 EPS is referred to as "basic" EPS because the total is not adjusted for dilution.
Full dilution means that every security that can be converted into common shares has been converted, indicating there will be fewer earnings available per share of common stock. Since EPS is a key measure of a company’s value and profitability, it is important for an investor to review basic EPS as well as fully diluted EPS.
Example of Fully Diluted Shares
Several types of securities can be converted into common stock, includingconvertible bonds, convertible preferred stock, employee stock options, rights, and warrants.
Assume that ABC issues 100,000 shares in stock options to employees to reward them for strong company performance. The firmhas convertible bonds outstanding that allow bondholders to convert their securities into a total of 200,000 shares of common stock. ABC also has convertible preferred stock outstanding and those shares can be converted into 200,000 shares of common stock as well.
Full dilution assumes that all500,000 additional common stock shares are issued, which increases the common shares outstanding to 1.5 million. Applying the $8 million in earnings to common shareholders, fully diluted EPS will be ($8 million / 1.5 million shares) or $5.33 per share, which is lower than the basic EPS of $8.00 per share.
FAQs
To calculate fully diluted shares, add the number of common shares the company would issue upon the exercise or conversion of all the potentially dilutive securities mentioned above to the current number of outstanding common shares.
How do you calculate dilution of shares? ›
A basic formula for calculating equity dilution is to divide a current shareholder's total number of existing shares by the sum of the total number of outstanding shares + the total number of new shares, as shown in the example above.
What is fully diluted vs diluted shares? ›
Basic and fully diluted shares are how the amount of shares investors hold in a company are measured. Basic shares include the stock held by all shareholders, while fully diluted shares are the total number of shares if the convertible securities of a company were exercised.
How do you calculate option dilution? ›
The finer points of calculating diluted EPS
- Amount paid = Options issued * Exercise price per share. ...
- Value of options in current shares = Amount paid to exercise options / Current share price. ...
- Diluted shares = Options issued-Value of options in current shares.
To calculate diluted EPS, take a company's net income and subtract any preferred dividends, then divide the result by the sum of the weighted average number of shares outstanding and dilutive shares (convertible preferred shares, options, warrants, and other dilutive securities).
What is fully diluted shares? ›
“Fully diluted” shares are the total common shares of a company counting not only shares that are currently issued and outstanding but also shares that could be claimed through the conversion of convertible preferred stock or through the exercise of outstanding options and warrants.
What is the formula for fully diluted? ›
Textbook formula is: Fully Diluted Value = Current Market Value of Equity + Convertible Securities + Options and Warrants + Restricted Stock Units (RSUs) Fully Diluted Value=Current Market Value of Equity+Convertible Securities+Options and Warrants+Restricted Stock Units (RSUs) Sometimes quite complex, if there are ...
Why are shares fully diluted? ›
Fully diluted is an important concept in venture capital because it affects the valuation of the company and the ownership percentage of investors. If an investor is only considering the current outstanding share count, they may be overestimating their ownership percentage and undervaluing the company.
Why use fully diluted shares? ›
Using fully diluted shares increases the number of shares used in the EPS calculation, reducing the dollars earned per share of common stock. If a business can generate more earnings per common share, the company is considered to be more valuable, and the share price may increase.
Do you use fully diluted shares to calculate market cap? ›
The market cap measures the value of a company's common equity as of the latest market closing date. The formula to calculate a company's market capitalization multiplies the total number of diluted outstanding shares by the latest market price at the present date.
Fully diluted EPS is calculated by subtracting preferred dividends from net income and then dividing the result by the sum of outstanding shares and potential dilutive securities. The formula for fully diluted EPS is (Net income - Preferred dividends) / (Outstanding shares + Conversion of dilutive securities).
What is the average diluted shares? ›
The Average Diluted Shares Outstanding is the amount of shares outstanding after all conversion possibilities are implemented over the reporting period. This measurement is important in understanding how a company's share price can change if everyone claims their share of stock.
What is the formula for dilution ratio? ›
The Dilution Ratio Calculation Formula
The procedure is straightforward: add the two numbers together and divide the total volume by that sum. For example, if your dilution ratio is 10 to 1 and you want to fill a 12-ounce bottle, you would add 10 and 1 to get 11.
What is share dilution by example? ›
For example, assume that a company issues 100 shares to 100 independent shareholders, with each shareholder having 1% ownership in the company. If the company issues 100 more shares to 100 other shareholders, the ownership of each shareholder reduces to 0.5%.
