The value of fully diluted shares of a company is an important analytical factor to determine its value and investment worthiness. Investors use it to determine a company’s Earning Per Share (EPS) and evaluate investment opportunities accordingly.
Fully diluted shares signify a company’s total outstanding shares, including post conversion quantity of all the convertible instruments issued; hence, it is important to understand its calculation and features. Before discussing the concept of fully diluted shares in detail, let’s understand the meaning of dilution.
What Is Dilution of Shares?
Issuing new stocks reduces the ownership percentage of each existing shareholder; this is known as the dilution of the shareholding of the existing shareholder. Equity dilution also happens when employees and noteholders convert their stock options/bonds into stocks.
To understand share dilution, follow this example of STQ Retail Limited. Let’s say the company has 10 existing shareholders owning 1 stock each. So each shareholder owns a 10% stake in this company.
STQ issues 10 new stocks purchased by 10 new shareholders. As a result, new shareholders now own a particular stake in the company, and the ownership percentage of each of the original shareholders has reduced. In this case, each shareholder now owns a 5% stake in this company. Hence, the value of each share has also reduced than earlier, known as the dilution of shares.
When a company offers Initial Public Offering (IPO) in the market, it issues a certain number of shares that are considered outstanding shares of this company.
Now that we have understood what dilution of shares means, let’s understand how fully diluted shares work.
What Are Fully Diluted Shares?
Fully diluted shares are a company’s total number of outstanding shares, including all convertible equities issued by a company. Convertible equity includes all the shares that can be claimed on the conversion of convertible preference shares/debentures, along with equity shares that can be claimed by exercising of options/warrants.
What Happens with Fully Diluted Shares?
Complete dilution of shares results in the following scenario:
- All convertible securities get converted into equity.
- It reduces the earnings per share (EPS) of a company.
- The ownership ratio of existing shareholders is reduced.
It is essential to calculate fully diluted shares as it helps to determine the potential of a company’s stock and calculate the EPS of a company. Usually, a fully diluted share signifies a low EPS; investors consider this when considering investing in the company.
How to Calculate Fully Diluted Shares?
Fully diluted shares of a company are calculated by identifying and analysing all convertible assets of a company. A company’s employees, bondholders, and note holders have such securities which can be converted into equity at some agreed terms and conditions.
You can calculate fully diluted shares of a company by following these steps.
Identify Eligible Options and Securities
- Convertible Bonds
These are company assets that pay regular returns to investors; however, you can convert these bonds into stocks. First, identify the total number of convertible bonds issued by the company and find out the bonds that are not converted yet and are eligible for conversion. Now, identify the conversion ratio for these bonds and multiply all eligible bonds with their conversion ratio.
- Stock Options
Similar to convertible bonds, stock options are offered to employees and certain stakeholders of a company. These are assets that can be converted into stocks later. To estimate the eligible stock options, add all issued stock options and subtract the expired, diluted, and ineligible ones. In addition, include external stock options that stakeholders hold. Now identify the number of stock options that can be converted into equity and sum up their value.
- Warrants
Warrants are issued securities that can be sold for cash and converted to shares. Third step to calculate the value of fully diluted shares is to consider all available warrants issued by a company and calculate the total number of shares all the eligible warrants can be converted into.
Add all the Convertible Shares
After identifying the number of convertible shares from each option, you need to add all the shares and get a total number.
Sum Up Total Outstanding Shares
The final step is to add the total convertible shares to the available outstanding shares of a company. The final number is the maximum dilution possible for a company stock according to its current equity distribution. The Earnings Per Share (EPS) of a company can be calculated from the total number of diluted shares once the value of the fully diluted shares is calculated.
Example of Fully Diluted Shares
To understand the concept of fully diluted shares and their calculation, refer to this example.
Let’s say a company named GF Infrastructure has 200 basic shares, 50 convertible shares from options, 70 from warrants and 60 from bonds. The fully diluted shares of this company would be as follows,
| Type of Shares | Number of Shares |
| Basic Shares | 200 |
| Options | 50 |
| Warrants | 70 |
| Bonds | 60 |
| Total Diluted Shares | 380 |
After calculating the fully diluted shares, let’s understand how this affects the company’s EPS. To calculate EPS, you should divide a company’s total earnings by the total number of outstanding shares.
Hence, if the number of basic shares of GF Infrastructure is 200, its fully diluted share quantity is 380, and its earning is ₹2000, then the EPS in both cases is demonstrated below.
| Type of Share | Number of Shares | Total Earnings | EPS |
| Basic Shares | 200 | ₹2000 | ₹10.00 |
| Fully Diluted Shares | 380 | ₹2000 | ₹5.26 |
You can see that the EPS of the company comes down upon full dilution.
What Are the Advantages of Fully Diluted Shares?
The dilution process provides an opportunity to raise more capital and increase the shareholders’ pool of a company. The company can also issue shares to existing shareholders and reduce ownership by external stakeholders.
What Are the Disadvantages of Fully Diluted Shares?
Fully diluted shares have the following disadvantages.
- EPS of a company is inversely proportional to the dilution of shares. Therefore, when the shares are fully diluted, the EPS of a company reduces.
- The shareholders’ ownership ratio and per-share value of a company’s equity decrease.
- The influence of shareholders in company decisions decreases as voting rights are affected.
Final Word
Share dilution of a company affects its equity value, performance and its reputation among investors. Fully diluted shares affect a company’s EPS; however, it increases its capital and shareholders. Therefore, to properly estimate the potential of a company, it is essential to calculate its fully diluted shares and their effect on the EPS.
Frequently Asked Questions
What are basic shares?
The shares that are issued originally during the IPO (Initial Public Offering) round before getting listed on the stock exchange are called basic shares. These shares do not get converted or issued in the secondary market.
Why is it important for a company to disclose fully diluted share data?
Investors prefer to invest in equities after thorough research to estimate the amount of risk involved; hence, it is usually a good practice on the part of a company if it is transparent when it comes to information related to the dilution of shares.
How to prevent share dilution for a shareholder?
To prevent a share value decrease during a dilution round, a shareholder needs to buy a significant percentage of the newly issued shares to maintain his/her ownership percentage.
Can stock dilution be reversed?
If a company buys back a significant amount of shares from the public market in the future, then the per-share value of a stock increases. This is technically a way to reverse stock dilution.
Vinit Kulkarni
Credit Principal at Wint Wealth
FAQs
What is the formula for fully diluted EPS? ›
Understanding Fully Diluted Shares
EPS represents net income minus preferred dividends, divided by the weighted average of common shares outstanding, in which the weighted average of common shares outstanding = (beginning period balance + ending period balance) / 2.
Diluted earnings per share (EPS) is a measurement of a company's earnings per share if all convertible securities were converted. Dilutive securities are securities that can be converted to common stock. Dilution devalues a shareholder's existing equity stake and reduces a firm's earnings per share.
What is EPS on a fully diluted basis? ›What is Fully Diluted EPS? Fully diluted EPS is a financial metric used to assess a company's profitability and earnings per share. It takes into account all potential dilutive securities that could convert into common stock and affect the number of outstanding shares.
What is the difference between EPS and fully diluted EPS? ›EPS takes into account a company's common shares, whereas diluted EPS takes into account all convertible securities, such as convertible bonds or convertible preferred stock, which are changed into equity or common stock.
How to calculate EPS? ›To calculate earnings per share, take a company's net income and subtract from that preferred dividends. Then divide that amount by the average number of outstanding common shares.
What is the basic EPS formula? ›Basic EPS consists of the company's net income divided by its outstanding shares. It is the figure most commonly reported in the financial media and is also the simplest definition of EPS.
What factors influence EPS? ›The primary factors that affect earnings per share is a company's earnings or income and the number of common shares outstanding. If the number of shares remains constant, an increase in income would increase EPS, whereas a decrease in income would cause a decrease in EPS.
Is a higher diluted EPS better? ›Diluted EPS delivers a good indicator of a company's financial health. A high diluted EPS means that the company is generating a lot of earnings per share. This is a positive sign for the company's financial health. One limitation of EPS dilution is that it does not take into account dilutive effect stock options.
What factors can lead to the dilution of EPS? ›Dilution to earnings can occur if the profitability of the target firm is lower than the acquirer's profitability. In some cases, the target firm may still be operating in the red. Another way EPS dilution could occur is if a higher share count results due to additional shares being issued for the deal.
What is a good EPS? ›Stocks with an 80 or higher rating have the best chance of success. However, companies can boost their EPS figures through stock buybacks that reduce the number of outstanding shares. So, strong profit growth also demands strong sales growth.
What are the assumptions of diluted EPS? ›
The basic assumption behind calculating diluted EPS is this – what if the firm's other convertible securities get converted into equity shares. If the firm's capital structure is complex and consists of stock options, warrants, debt, etc., and outstanding equity shares, diluted earnings per share must be calculated.
Which is better basic or diluted EPS? ›Diluted EPS is more scientific than basic EPS. For fundamental analysis, diluted EPS is more effective as it includes the impact of all potential equity diluters. This ensures the company's EPS is in line with future expansion. Hence, this is more important for the P/E calculation.
Does EPS use basic or diluted shares? ›Basic EPS is calculated by dividing a company's income or profit by a certain number of shares outstanding. Diluted EPS takes into account all potential dilution that would occur if convertible securities were exercised or options were converted to stocks.
Is basic EPS usually higher or lower than diluted EPS? ›The basic EPS is useful for companies that have a simple capital structure. And, diluted EPS. read more for companies that have complex capital structures. Basic EPS is always higher than diluted EPS since, in diluted EPS, all convertible securities add to the common shares in the denominator.
How is EPS calculated with example? ›- Determine the company's net income from the previous year. ...
- Determine the number of shares outstanding. ...
- Divide the net income by the number of shares outstanding. ...
- Determine the company's dividends on preferred stocks. ...
- Subtract the company's dividends from its annual net income.
Earnings per share ratio Example - 1
So, the Weighted average number of common shares becomes (50,000 * 1) + (40,000 * 0.5) = 50,000 + 20,000 = 70,000 shares. Earnings per share ratio = $420,000 / 70,000 = $6 per share.
EPS is determined by dividing a company's net profit by the number of its outstanding shares of common stock. The higher the EPS of a company, the more profitable it is considered. Companies declare their EPS every quarter and in their annual results.
What is the formula for calculating EPS in Excel? ›After collecting the necessary data, input the net income, preferred dividends and number of common shares outstanding into three adjacent cells, say B3 through B5. In cell B6, input the formula "=B3-B4" to subtract preferred dividends from net income. In cell B7, input the formula "=B6/B5" to render the EPS ratio.
What is the two class method of EPS? ›Earnings per share (“EPS”) is calculated under the two-class method under which all earnings (distributed and undistributed) are allocated to each class of common stock and participating securities based on their respective rights to receive dividends.
Does EPS include dividends? ›Earnings per share or EPS is calculated as a company's earnings – which do not account for the distribution of dividends — divided by the outstanding shares. Investors track this metric to get a sense of the progress of a company and determine the valuation.
What are the 5 limitations of EPS? ›
- The organizations can manipulate the earnings per share by buyback of shares or by splitting stocks.
- It does not include the performance of the organization as inflation is ignored.
- It does not consider the cash flow generated by the organization.
Earnings per Share (EPS) Explained
The ratio can be manipulated if the company were to buy or sell its own shares in the market, referred to as Treasury Stock. The net income aspect can also be manipulated through the recognition of revenue as well as other ways.
Companies can increase their EPS in two ways: increase net income and reduce shares outstanding. If the outstanding shares remain relatively constant, a company could boost the EPS by increasing the net income.
What is the best EPS ratio of a stock? ›Typically, the average P/E ratio is around 20 to 25. Anything below that would be considered a good price-to-earnings ratio, whereas anything above that would be a worse P/E ratio.
Why diluted EPS is important? ›The diluted EPS formula reduces preference dividends from net income. The focus is on calculating the Earnings Per Share (EPS) for common shareholders. The denominator is the weighted average of outstanding shares, including the common shares and dilutive securities, such as stock options or convertible bonds.
What is the formula for diluted shares? ›The formula for diluted earnings per share is a company's net income (excluding preferred dividends) divided by its total share count -- including both outstanding and diluted shares.
What happens when shares are diluted? ›What is share dilution? Share dilution (also called equity dilution) is the decrease in ownership percentage for existing shareholders when new shares are issued or reserved. It occurs after material events, such as a fundraise or when an employee option pool is created.
How do I know if my EPS is good? ›Bottom Line. There's no fixed answer for what is a good EPS. When comparing companies, it's helpful to look closely at how EPS is trending and how it matches up to competitor earnings. Remember that a higher EPS can suggest growth and stock price increases.
What is a good and bad EPS? ›... there is no rule-of-thumb figure that is considered a good or bad EPS, although obviously the higher the figure the better. ... investors tend to use it to compare companies in the same sector and to look for trends in an individual company's performance.
What is a good annual EPS growth rate? ›EPS Rating: Ranks each stock from 99 (best) to 1 (worst) in terms of both current quarterly and annual earnings growth. The best stocks typically have an EPS Rating of 95 or higher, which means they're in the top 5% of all stocks in terms of earnings-per-share performance.
What is an example of a diluted share? ›
General Example of Dilution
Suppose a company has issued 100 shares to 100 individual shareholders. Each shareholder owns 1% of the company. If the company then has a secondary offering and issues 100 new shares to 100 more shareholders, each shareholder only owns 0.5% of the company.
Diluted EPS is often referred to as a worst-case scenario measurement, where the effect on earnings per share is measured assuming that all potential additional common shares for convertible securities, options, and warrants have already been issued since the beginning of the year.
What is a high EPS? ›High earnings per share typically mean that a company is more likely to have extra profit to distribute to its shareholders as dividends. Since EPS is so widely used by investors who choose stocks, a high EPS can attract investors and further drive up share prices.
Where should basic and diluted EPS be presented in the financial statements? ›An enterprise should present basic and diluted earnings per share on the face of the statement of profit and loss for each class of equity shares that has a different right to share in the net profit for the period.
What is the difference between shares and fully diluted shares? ›Basic shares include the stock held by all shareholders, while fully diluted shares are the total number of shares if the convertible securities of a company were exercised. These securities include stock options, stock warrant, and convertible bonds, among other things.
Can diluted EPS be equal to basic EPS? ›Basic EPS is always higher than diluted EPS and at best the Diluted EPS can be equal to the Basic EPS. That is because; in diluted EPS all convertible securities are added to the common shares in the denominator. Remember, EPS is the first step to calculating the P/E Ratio as a valuation metrics.
What if basic and diluted EPS are same? ›Both basic EPS and diluted EPS are important metrics for companies to find an accurate PE ratio. Basic EPS takes into account only the common shares in the calculation process whereas diluted EPF takes both common shares along with convertible securities of any company.
How do you calculate fully diluted? ›The calculation of “fully diluted” shares for a company is generally made so that an individual stock owner can determine their “fully diluted” ownership percentage, which is the number of common shares owned by that owner divided by the total fully diluted shares.
How do you calculate the number of fully diluted shares? ›Calculating Fully Diluted Shares. Fully diluted shares are calculated as basic shares outstanding plus the potential additional shares resulting from in-the-money dilutive securities.
How do you calculate basic EPS and diluted EPS? ›By subtracting the preference dividend from net income and dividing the result by the total number of outstanding equity shares, you will be able to compute basic earnings per share or basic EPS. On the other hand, diluted EPS needs to be determined by adding dividends, net income, debt interest, etc.
How do you calculate fully diluted valuation? ›
Fully Diluted Valuation = Token Price X Maximum Supply
The maximum supply includes the tokens that are in circulation and the tokens pending distribution. Essentially, it is the maximum number of coins coded to exist in the lifetime of the cryptocurrency.
Using fully diluted shares increases the number of shares used in the EPS calculation, reducing the dollars earned per share of common stock. If a business can generate more earnings per common share, the company is considered to be more valuable, and the share price may increase.
What is an example of dilution of shares? ›More about equity dilution
In the example below, ABC Co. started with 100,000 shares owned by 100 unique shareholders—meaning each shareholder owned 1% of the company. To raise more capital, the business issued 10,000 new shares to 10 new shareholders, so that 110 shareholders now own 0.9% of the company each.
Basic and fully diluted shares are how the amount of shares investors hold in a company are measured. Basic shares include the stock held by all shareholders, while fully diluted shares are the total number of shares if the convertible securities of a company were exercised.
What is fully diluted price per share? ›What Is the Diluted Share Price? Diluted earnings per share (EPS) means that earnings are reported on a hypothetical amount of outstanding shares. It is calculated by dividing the net income for a firm during a given reporting period by the total amount of shares outstanding plus all shares authorized for issuance.
How to calculate fully diluted shares using treasury stock method? ›The diluted share count is 105,000 = 100,000 basic shares + 5,000 additional shares. The diluted EPS is then equal to $4.76 = $500,000 net income ÷ 105,000 diluted shares.
What does it mean when a share is diluted? ›Share dilution is when a company issues additional stock, reducing the ownership proportion of a current shareholder. Shares can be diluted through a conversion by holders of optionable securities, secondary offerings to raise additional capital, or offering new shares in exchange for acquisitions or services.
Do you use diluted shares to calculate equity value? ›Basic equity value is calculated by multiplying a company's share price by the number of basic shares outstanding. On the other hand, diluted equity value is calculated by multiplying the share price by the number of diluted shares outstanding.
Does equity value use fully diluted shares? ›Equity value is found by taking the company's fully-diluted shares outstanding and multiplying it by a stock's current market price. Fully diluted means that it includes in-the-money options, warrants, and convertible securities, aside from just the basic shares outstanding.