What are Fully Diluted Shares Outstanding?

Fully diluted shares are the total outstanding shares a company would have after all dilutive securities, such as convertible preferred stock and warrants, have been assumed as converted or exercised.

It’s important to understand the difference between total outstanding shares and total fully diluted outstanding shares because they are used for computing the basic and diluted earnings per share (EPS).

Fully diluted shares= total outstanding shares + ESC

Where:


Total outstanding shares = equity shares authorized and issued by the company

ESC = equity shares after conversion of convertible securities


Convertible securities may include convertible preferred stock, convertible bonds, and other obligations such as employee stock options, warrants, etc.

Authorized vs. outstanding vs. fully diluted shares

A company’s shares could be classified as authorized, outstanding, and fully diluted shares outstanding.

Authorized shares

Authorized shares are the total shares a company is legally allowed to issue as per its articles of incorporation. There is no floor or cap on how many shares a company can authorize in its articles of incorporation; it may be 10 shares or 10M shares.

Outstanding shares

When some of the authorized shares are issued to an investor, they become outstanding. Since outstanding shares must be authorized and issued, the number of outstanding shares can never exceed the number of authorized shares.

Fully diluted shares

A company may have issued convertible securities in addition to equity shares. When converted, these securities will increase total outstanding shares and result in dilution of stake for current investors. Therefore, investors like to know the number of fully diluted shares, which is equal to outstanding shares plus the number of equity shares that convertible securities may be converted into at the current market price.

Effect of dilution on EPS 

EPS can be either basic or diluted. Let’s look at the formula for computing basic and diluted EPS to understand how it is impacted by dilution.

Basic EPS formula
Diluted EPS formula

Where:


WASO = weighted average shares outstanding

ESC = equity shares after conversion of convertible securities


Therefore, an increase in the number of outstanding shares reduces the EPS.


EPS is used as an input by financial analysts in various relative valuation formulas such as the price-to-earnings ratio. When the EPS changes, these multiples may change as well. Also, if a company’s basic EPS is significantly higher than its diluted EPS, it may raise concerns regarding future dilution among investors.

Example

Company A has a net income for the current year of $100M. From this $100M, company A must first pay a preferred dividend of $20M to preferred shareholders. The remaining $80M is the net income available to equity shareholders.


The company has 50M outstanding shares and other obligations are as follows:

Table showing an example of fully diluted shares outstanding

The company’s basic EPS can be calculated by dividing the net income available to shareholders by the total outstanding shares, i.e., $80M ÷ 50M shares = $1.6 per share.


Diluted EPS can be calculated by adding company A’s other obligations to the total outstanding shares and using that figure as the denominator. The fully diluted shares outstanding for company A are 70M (50M + 10M + 8M + 2M). The numerator remains unchanged. Therefore, company A’s diluted EPS is $1.14 per share, i.e., $80M ÷ 70M shares.


Things to note:


The scenario has been simplified just for understanding. In reality, stock options are exercised only when they are in the money, i.e., their strike price is below the market price. Therefore, stock options that are out of the money aren’t added to the denominator of the diluted EPS formula. This changes the diluted EPS and narrows the difference between basic and diluted EPS.


The numerator also changes if convertible bonds or convertible preferred stock are converted to equity shares because the company will no longer have interest expenses or need to pay preferred dividends. The reduced interest expense also reduces the company’s tax expense since it is tax-deductible. Note that this applies only to convertible bonds, not to convertible preferred stock because preferred dividends aren’t tax-deductible.


Fully diluted shares outstanding include all potential future conversions of convertible securities, which may or may not happen. However, these conversions could have a considerable impact on a company’s earnings per share and consequently the value of an investor’s holdings. 


Fully diluted shares outstanding tell potential investors how much their stake may be diluted in the future. It also gives investors who rely on earnings multiples such as P/E a clearer picture of how a multiple’s denominator may change as and when the convertible securities are converted.