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.
Fully Diluted Shares
Definition
Fully diluted shares refer to the total number of common shares of a company, assuming all possible sources of conversion (such as convertible bonds and employee stock options) are exercised. Fully diluted shares include not only the currently issued shares but also those that can be obtained through conversion. This number is crucial for calculating the company's earnings per share (EPS), as using fully diluted shares increases the share base in the calculation, thereby reducing the earnings per share for common stock.
Origin
The concept of fully diluted shares originated from the need for accurate financial reporting, particularly in calculating earnings per share (EPS). With the diversification of financial instruments such as convertible bonds, stock options, and warrants, traditional EPS calculation methods could no longer accurately reflect a company's profitability. Thus, the concept of fully diluted shares emerged to provide more comprehensive financial information.
Categories and Characteristics
Fully diluted shares mainly include the following categories:
- Issued Common Shares: Common shares currently circulating in the market.
- Convertible Securities: Such as convertible bonds and convertible preferred shares, which can be converted into common shares under certain conditions.
- Stock Options and Warrants: Options and warrants held by employees or investors that can be used to purchase the company's common shares at a predetermined price in the future.
The characteristic of fully diluted shares is that it considers all potential equity dilution factors, providing a more conservative method for calculating earnings per share.
Specific Cases
Case 1: A company currently has 10 million issued common shares, along with 2 million shares of convertible bonds and 1 million shares of employee stock options. If all convertible bonds and stock options are exercised, the company will have 13 million fully diluted shares. Using fully diluted shares in EPS calculation will more accurately reflect the company's profitability.
Case 2: Another company has 5 million issued common shares, 500,000 shares of convertible preferred stock, and 1.5 million shares of warrants. If all these securities are converted, the company will have 7 million fully diluted shares. This number is used in financial statements to calculate EPS, providing a more comprehensive view of the financial situation.
Common Questions
Question 1: Why use fully diluted shares to calculate EPS?
Answer: Fully diluted shares consider all potential equity dilution factors, providing a more conservative and comprehensive method for calculating EPS, helping investors more accurately assess the company's profitability.
Question 2: What impact do fully diluted shares have on investors?
Answer: Fully diluted shares increase the share base in the calculation, usually reducing EPS, which may affect investors' judgment of the company's profitability.
