What are Fully Diluted Shares?
Fully diluted shares are the total number of shares that will be outstanding, including convertible debt, warrants, restricted stock units and employee stock options. Simply put, it is the total number of shares that would result if all convertible securities had been exercised into common stock.
Fully diluted shares are used by analysts to get a fair valuation of a company.
What is Earnings Per Share (EPS)?
Earnings per share (EPS) is one of the many ratios used to evaluate a business's financial performance and its worth.
It is calculated by dividing net income available to common stockholders ("earnings") by the number of common shares outstanding ("shares"). It represents the dollar amount of earnings a public company generates per share of its common stock.
Example of Fully Diluted Shares
Let's look at an example of a company to help you better understand fully diluted shares. Securities such as convertible bonds, rights, warrants, employee stock options, and convertible preferred shares can be converted into common stock.
Consider a company that has already issued 100,000 shares.
In addition, the company issues 10,000 shares as part of an employee stock option plan to reward its employees.
The company also has convertible bonds that allow investors to convert their securities into 20,000 shares of common stock. Besides, the company also holds convertible preferred stock and those shares can be converted into 20,000 shares of common stock as well.
In the full dilution scenario, all 50,000 additional shares are issued. This brings the number of outstanding common shares to 150,000.
A company's earnings are usually presented in two forms, basic earnings per share and diluted EPS. Basic EPS is calculated by dividing net earnings by the weighted average number of common shares outstanding. Diluted EPS takes into account the potential dilution that could occur if the company issues more shares.
Suppose that the company had earned $800,000. Then, the fully diluted earnings per share comes to $5.33 per share. This is calculated by the earnings divided by the total outstanding shares after dilution ($800,000/ 150,000 shares).
Fully diluted EPS = Earnings/ Total outstanding shares after dilution
Whereas the basic EPS would be higher at $8.00 per share ($800,000/ 100,000 shares).
Basic Shares vs Fully Diluted Shares
Usually, companies report their earnings per share using their basic shares or fully diluted shares. The Financial Accounting Standards Board introduced this method in 1997.
Basic Shares are preferred shares that include the stock held by all the shareholders. Meanwhile, fully-diluted shares refer to the total number of shares that would be outstanding if all the convertible securities of a company were exercised.
When calculating a company's market value of equity (also known as market value of equity), diluted shares must always be included, since the market values shares based on diluted shares.
Basic and fully diluted shares are used to determine how many shares the shareholders hold in a company. It's these shares that show investors their portion of the company's profits.
EPS and Fully Diluted Shares
A full dilution occurs when all securities convertible into common shares have been converted.
Fully diluted shares are used for calculating a company’s earnings per share (EPS). Including the fully diluted shares results in an increase in the shares, thereby reducing the dollars earned per common share.
A business with large earnings and few outstanding shares will have a higher EPS than a business with smaller earnings and a larger number of outstanding shares.
For example, a company's EPS for this quarter may have been $6.89, while its EPS for the last quarter was $4.55.
The EPS for the most recent quarter is higher, so you can conclude that the company's financial situation is getting better.
In general, a higher EPS is seen as a positive development, while a lower EPS can be an indication of concern. A company that consistently produces a low EPS is most likely a low-growth company that is not doing a good job of converting its assets into cash.
A company's earnings per share (EPS) is a key measure of its value and profitability, so it's vital for investors to consider both the basic earnings per share and fully diluted earnings per share.