Fully Diluted Shares

Definition

Fully diluted shares refer to the total number of common shares of a company after all possible sources of conversion, such as convertible bonds and employee stock options, have been exercised. Fully diluted shares include not only the shares currently issued but also those that can be obtained through conversion. This number is crucial for calculating a company's earnings per share (EPS), as using fully diluted shares increases the share base in the calculation, thereby reducing the earnings per share of common stock.

Origin

The concept of fully diluted shares originated from the need for accurate financial reporting, especially in the mid-20th century, as financial instruments became more diverse and complex. Companies needed a way to accurately reflect the impact of potential equity dilution on earnings per share. This concept helps investors better assess a company's profitability under all potential equity dilution scenarios.

Categories and Features

Fully diluted shares primarily include two categories: convertible securities, such as convertible bonds and convertible preferred stock, and stock options and warrants. The common feature of these instruments is that they can be converted into common stock at some future point, thereby increasing the total share capital of the company. Calculating fully diluted shares helps investors understand the company's capital structure under all potential dilution scenarios.

Case Studies

A typical case is Tesla Inc. Tesla details the calculation of fully diluted shares in its financial reports, including the impact of employee stock options and convertible bonds. Another example is Apple Inc., which discloses the number of fully diluted shares in its annual reports to help investors understand the earnings per share under all potential dilution scenarios.

Common Issues

Investors often misunderstand the calculation of fully diluted shares, thinking it is merely a simple addition of issued shares. In reality, fully diluted shares require consideration of all potential conversion instruments, which can significantly increase the share capital. Additionally, investors may overlook the impact of fully diluted shares on earnings per share, underestimating the potential impact of dilution on profitability.