Fully Diluted Shares: Meaning, Calculation & How it Affects EPS

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

1. 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.

2. 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. 

3. 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,

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.

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. 

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