What are Fully Diluted Shares?
Let me explain fully diluted shares to you directly: they represent the total number of common shares that would be outstanding and available to trade on the open market if all possible sources of conversion—such as convertible bonds, warrants, employee stock options, and others—are exercised. These include not only the shares currently issued but also all that could be created through those conversions.
You should know that companies use the fully diluted share count when calculating earnings per share (EPS). By increasing the number of shares in this calculation, fully diluted shares lower the EPS, as the same amount of earnings is now spread across a larger number of shares.
Key Takeaways
While full dilution may not occur all at once, it indicates how many shares might theoretically become outstanding, assuming full conversion. Earnings paid to preferred shareholders as cash dividends are subtracted from net income because EPS applies only to common shareholders. Company policies regarding conversions may change over time, potentially impacting expectations about the future number of fully diluted shares.
Understanding Fully Diluted Shares
The number of fully diluted shares directly affects the EPS of a company, a key metric you use to assess relative value and profitability. EPS is calculated by dividing net income (after preferred dividends) by the weighted average number of common shares outstanding. The weighted average is typically calculated as: (beginning period balance + ending period balance) / 2.
If a company increases earnings per common share, it is generally considered more valuable, which may lead to a rise in its publicly traded share price. As the number of outstanding shares plays a key role in the EPS calculation, it’s important for you to be aware of any potential dilution that can reduce the EPS.
Factoring in Fully Diluted Shares
Assume that ABC Corporation (ABC) generates $10 million in net income and pays preferred shareholders a total of $2 million in dividends. This leaves $8 million available to common shareholders. If the firm’s weighted average of common shares outstanding totals 1 million, the EPS will be $8.00 per share: $8 million / 1 million shares = $8 per share.
This $8.00 EPS is referred to as 'basic' because the total is not adjusted for dilution. Full dilution assumes that all convertible securities, such as stock options, convertible bonds, or warrants, are exercised and converted into common shares. This increases the number of shares and, consequently, reduces the earnings available per each share. Since EPS is a key measure of a company’s value and profitability, it is important for you as an investor to review basic EPS as well as fully diluted EPS.
Fast Fact
Stock brokers with robust research tools may include the fully diluted share count in the company’s financial metrics section.
Example of Fully Diluted Shares
Several types of securities can be converted into common stock, including convertible bonds, convertible preferred stock, employee stock options, rights, and warrants.
Assume that the same ABC company, with 1 million outstanding shares, issues 100,000 shares in stock options to employees to reward them for strong performance. The firm has 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 all 500,000 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 now only be ($8 million / 1.5 million shares) or $5.33 per share, significantly lower than the basic EPS of $8.00 per share.
Other articles for you
A Pareto improvement is a change in resource allocation that benefits at least one person without harming anyone, leading toward Pareto efficiency in economic systems.
NAFTA was a 1994 trade agreement between the US, Canada, and Mexico that eliminated most tariffs to boost trade, later replaced by the USMCA in 2020.
A bullet repayment is a large lump-sum payment of a loan's principal at maturity, often used in balloon loans to lower monthly payments but requiring careful planning for the final payout.
409A plans are non-qualified deferred compensation options that let high earners save more for retirement by deferring taxes on income not yet received.
The home market effect explains why countries with large domestic demand for certain goods tend to produce and export more of them, especially those with high economies of scale and transport costs.
An official strike is a legally endorsed work stoppage by union members that provides protections against employer retaliation.
Unlisted securities are financial instruments traded over-the-counter rather than on formal exchanges due to not meeting listing requirements.
The term yuppie refers to young, affluent urban professionals, originating in the 1980s as a derogatory label that has evolved over time.
Convertible bonds are hybrid securities that combine fixed-income features with the option to convert into company stock for potential equity gains.
This text explains what a taxpayer is, including individuals and businesses, their tax obligations, filing statuses, thresholds, rates, and related forms.