When considering the value of a publicly traded company's stock, you may want to take into account more than just the number of shares outstanding. Although a company's financial data can be estimated easily using the number of issued shares of stock, there is an "X factor" that could reduce, or dilute, the company value: stock options.
A stock's outstanding shares are simply the number of common shares that a company has issued. In other words, if Norton Dog Biscuits Inc. has issued 2 million common shares that trade on the New York Stock Exchange, then 2 million is the number of shares outstanding. Some stocks have preferred shares, which can be included.
A stock that is fully diluted takes into account the number of outstanding options of all types that have been authorized by the company and could eventually be cashed in to create new shares. That means if Norton Dog Biscuits also has 250,000 granted stock options, the fully diluted number of shares would be 2.25 million, the 2 million common shares plus the 250,000 stock options.
What Dilutes a Stock?
There are a number of items that can be added to common stock to dilute it. These include issued stock options and reserved options, as well as warrants and convertible preferred stock or debt that can be exchanged for common stock. To find the fully diluted stock total, calculate as if all options and convertibles have been issued and exercised.
What This Means
The fully diluted number of shares can dramatically affect some important financial measures of a company's health. For instance, the earnings per share figure is calculated by dividing the total earnings for a given time period by the number of shares outstanding. If you use the fully diluted number rather than the outstanding number, this could radically change the EPS if there is a large disparity between the two figures. As there can only be a negative effect on EPS when using diluted shares rather than basic shares, many investors prefer to look at the diluted number when judging a company's performance.
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- IBankingFAQ: What Is the Difference Between Basic Shares and Fully Diluted Shares?
- Frederic W. Cook & Co., Inc.: The True Cost of Stock Options
- Jacobsen & Wachterhauser: Diluted EPS Vs Basic EPS
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