DEFINITION of 'If-Converted Method'

Investors use the if-converted method to calculate the value of convertible securities if they were converted into new shares. In-the-money convertible securities (securities where the stock price is above the exercise price) are generally considered during the if-converted method.

BREAKING DOWN 'If-Converted Method'

Convertibles securities are often bonds or preferred shares that inherently have the option to convert into common stock. This is a feature that the issuer will add to the security at the time of issuance to “sweeten the deal” for investors and give them more flexibility to gain value, depending on the direction of the market and/or issuer itself.

Convertibles are often associated with convertible bonds. These allow bond holders to convert their creditor positions to those of equity holders at an agreed-upon price. Other convertible securities can include notes and preferred shares.

The number of shares an investor may receive is calculated on the basis of the convertible security’s conversion ratio. This is the ratio at which investors can convert bonds into stocks; that is, the number of shares an investor gets for each bond. The conversion rate may be fixed or change over time, depending on the terms that the issuer has set for the offering.

For example, a conversion rate of 25 means that for every $1,000 of par value the convertible bondholder converts, she receives 25 shares of stock. Investors can determine the price at which it becomes profitable to convert bonds into equity shares by dividing the selling price of the bond by the conversation rate to determine the breakeven price.

Recent Example of the If-Converted Method

Stericycle released unaudited condensed consolidated statements of income for the three months ended March 31, 2018. Under the if-converted method diluted shares outstanding were 90.7, down 0.1% from 90.8 in the same quarter in 2017.

Stericycle calculated its EPS by using the if-converted method of share dilution. The company described how this method provided insight to how its diluted share count would be affected after preferred shares converted to common shares. Specifically, the impact under the "if-converted" method to Stericylce’s adjusted diluted EPS was $0.06 and $0.07 for the first quarter 2018 and 2017, respectively.

It’s important for companies to list if-converted accounting considerations in its financial statements as a conversion into shares increases the total number of shares outstanding. This can reduce a company’s earnings per share or EPS.

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