What are Fully Diluted Shares?
Fully diluted shares outstanding is the total number of shares a company would theoretically have if all dilutive securities were exercised and converted into shares. Dilutive securities include options, warrants, convertible debt, and anything else that can be converted into shares. For a financial analyst, it is important to have a solid understanding of the difference between basic vs fully diluted shares and what it means for key metrics like EPS.
Diluted Shares -> Impact on EPS
Public companies are required to report both Basic and Diluted Shares, which they use in their calculation of Earnings Per Share (EPS). Below are an explanation and comparison of Basic EPS vs Diluted EPS.
Basic earnings per share is calculated by taking the total net income from the period and dividing it by the weighted-average shares outstanding during the period.
Diluted earnings per share is derived by taking net income during the period and dividing by the average fully diluted shares outstanding in the period. The diluted shares are calculated by taking into account the effect of employee stock awards, options, convertible securities, etc.
When EPS is Negative (a Loss)
When companies experience a period with a loss or negative EPS, they will not include dilutive securities in the calculation of EPS, as they would have an anti-dilutive effect.
Below is an example of what Amazon discloses in their 10-k about how many basic and diluted share they have outstanding.
Stock Based Compensation
Most public companies use stock based compensation as a way of incentivizing and rewarding their employees. By granting stock to employees, the companies are increasing the number of shares outstanding, which causes dilution and needs to be factored into the financial analysis.
Employee stock options, shares, and restricted share units are subject to a vesting period, typically between two and five years. Since some employees will quit before their shares vest, companies typically make an estimate, based on judgment, about forfeitures and the total number that will actually vest.
This category is often one of the biggest causes of dilution to shares outstanding.
Fully Diluted Shares Outstanding Example
Below is an example of how to calculate diluted shares outstanding for a company, as well as basic and diluted EPS. As you can see, the basic shares are increased by the effect of options, warrants, and employee shares that have been issued.
The company has $1.2 billion of net earnings, so its basic EPS is $2.40 and its diluted EPS is $2.35.
Thank you for reading this guide to understanding the impact of options, employee shares, and other securities on the number of shares outstanding for a company. CFI is the official provider of the Financial Modeling & Valuation Analyst (FMVA)™ designation, which is designed to transform anyone into a world-class financial analyst.
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