A:

When a corporation releases its financial information, there are a few different variations used when reporting total earnings. These variations are: total dollar amounts, earnings as a percent of total revenue, earnings per share (EPS) and diluted EPS. The last item, diluted EPS, means that earnings are reported on a hypothetical amount of outstanding shares, and 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. Examples of shares that can be authorized at a future date include those that result from call options and convertible bonds. This type of earnings analysis is very helpful when analyzing a firm's financial information and stock price.

The rationale behind such an analysis is to evaluate the effect that issuing all of the authorized stock at once would have on the company's underlying stock price. Because the number of shares outstanding increases, the value of all per-share figures reported will fall, and analyzing a firm on this basis would provide the investor with a better sense on the "true" value of a firm on a per-share basis.

For example, suppose that a company has 5 million shares outstanding with a share price of $35, a market cap of $175 million and a reported net income of $3 million. The board of directors has also authorized a new issuance of 1 million shares, plus another 500,000 shares in stock options. The current EPS is $0.60, and is represented in the current stock price of $35. On a fully-diluted basis, we would get an EPS figure of $0.46 ($3 million/6.5 million shares).

If all parties exercised their options and the firm issued all approved shares, the share price would fall because there would be an increase in the number of shares outstanding. Because the firm would not have immediately changed in value after the number of shares outstanding increased, the market cap would remain the same at $175 million, but the share price would fall to about $30 per share ($175 million/6.5 million shares).

It is useful to analyze a firm on a fully-diluted basis because it better represents the firm's financial strength, especially earnings. Although every individual may not exercise every option at the same time, it is useful to see what would happen if they did because this provides investors with a very conservative estimate of company earnings.

For more information, have a look at Getting The Real Earnings.

RELATED FAQS
  1. Why do companies release financial figures in terms of fully diluted shares outstanding?

    Learn why companies release their financial figures in terms of fully diluted shares outstanding so as to give a true picture ... Read Answer >>
  2. Why is a company's diluted EPS always lower than its simple EPS?

    Learn about diluted and basic earnings per share and why a company's diluted earnings per share is usually lower than its ... Read Answer >>
  3. What's the difference between basic shares and fully diluted shares?

    Find out more about basic outstanding shares, fully diluted shares, the difference between the calculation of shares and ... Read Answer >>
  4. Why would I need to know how many outstanding shares the shareholders have?

    Find out why shareholders should know how many outstanding shares have been issued by a corporation, and learn what happens ... Read Answer >>
  5. What is the difference between weighted average shares outstanding and basic weighted ...

    Outstanding shares refers to stock that is currently held by investors, including shares held by the public, and restricted ... Read Answer >>
  6. What is the weighted average of outstanding shares? How is it calculated?

    The amount of shares outstanding in a company will often change due to a company issuing new shares, repurchasing and retiring ... Read Answer >>
Related Articles
  1. Investing

    The Dangers Of Share Dilution

    Investors need to be aware of the existence of dilutive securities and how they can affect existing shareholders.
  2. Investing

    Getting The Real Earnings

    EPS helps investors analyze earnings in relation to changes in new-share capital.
  3. Investing

    Investment Valuation Ratios

    Learn about per share data, price/book value ratio, price/cash flow ratio, price/earnings ratio, price/sales ratio, dividend yield and the enterprise multiple.
  4. Investing

    The 5 Types Of Earnings Per Share

    A look at the five varieties of EPS and what each represents can help an investor determine whether a company is a good value, or not.
  5. Managing Wealth

    Calculating Basic Earnings Per Share

    Basics earnings per share measures the amount of net income earned per share of outstanding stock.
  6. Investing

    What are Issued Shares?

    Issued shares are the amount of authorized stocks a company’s shareholders buy and own. The annual report shows the number of outstanding shares.
  7. Investing

    Assess Shareholder Wealth With EPS

    Find out if management is doing its job of creating profit for investors.
  8. Investing

    The Basics Of Outstanding Shares And The Float

    We go over different types of shares and what investors need to know about them.
  9. Investing

    The Dangers Of Share Dilution

    Share dilution reduces the value of an individual investment and can drastically impact a portfolio.
  10. Investing

    The Weighted Average Of Outstanding Shares

    The quantity of a company’s outstanding shares changes when it issues new shares, repurchases or retires existing ones, or converts others.
RELATED TERMS
  1. Fully Diluted Shares

    The total number of shares that would be outstanding if all possible ...
  2. Earnings Per Share - EPS

    The portion of a company's profit allocated to each outstanding ...
  3. Basic Earnings Per Share

    A rough measurement of the amount of a company's profit that ...
  4. Diluted Earnings Per Share - Diluted EPS

    Diluted Earnings Per Share (or Diluted EPS) is a performance ...
  5. Diluted Normalized Earnings Per Share

    A company's profit less one-time earnings, divided by both outstanding ...
  6. Issued Shares

    The number of authorized shares that is sold to and held by the ...
Hot Definitions
  1. Taxable Income

    Taxable income is described as gross income or adjusted gross income minus any deductions, exemptions or other adjustments ...
  2. Chartered Financial Analyst - CFA

    A professional designation given by the CFA Institute (formerly AIMR) that measures the competence and integrity of financial ...
  3. Initial Coin Offering (ICO)

    An Initial Coin Offering (ICO) is an unregulated means by which funds are raised for a new cryptocurrency venture.
  4. The Bernie Madoff Story

    Bernie Madoff ran a multibillion-dollar Ponzi scheme that is considered the largest financial fraud of all time.
  5. Pyramid Scheme

    An illegal investment scam based on a hierarchical setup. New recruits make up the base of the pyramid and provide the funding, ...
  6. Ponzi Scheme

    A fraudulent investing scam promising high rates of return with little risk to investors. The Ponzi scheme generates returns ...
Trading Center