Financial statements report the basic shares outstanding. However, when attempting to value a company’s market value of equity, fully diluted shares outstanding is used instead of the basic shares outstanding number. Fully diluted shares outstanding provides a better representation of how the market is implicitly valuing the company.

Basic Shares Outstanding
Basic shares outstanding are the total shares that a company issued and are outstanding. This number is directly reported on the financial statements. Not all shares that are issued are still outstanding. For example, treasury stock reduces the number of shares outstanding. Treasury stock are shares repurchased by the company in the secondary market.

Fully Diluted Shares Outstanding
Fully diluted shares outstanding are the company’s outstanding shares, adjusted for potentially dilutive securities and stock options. Convertible debt is an example of a dilutive security. If the convertible debt is converted to equity shares that increases the total number of shares outstanding.

Calculating Fully Diluted Shares Outstanding
Fully diluted shares outstanding are calculated using the treasury stock method and or the if-converted method. The treasury stock method accounts for the share impact of options, and the if-converted method accounts for the share impact of convertible debt and or preferred stock.

Treasury Stock Method
The treasury stock method includes the impact of stock options by calculating the additional shares created when the options are exercised. Only in the money options are included because out of the money options are anti-dilutive as the options would never logically be exercised. This method also assumes that proceeds from the sale of stock when options are exercised are used to repurchase shares at the current price. This partially offsets options’ dilutive effect.

Fully diluted shares are then calculated by adding the additional shares to the basic shares. Additional shares are calculated by determining how many new shares could be purchased from the profits of exercising in the money options. The calculation is current stock price minus strike price divided by stock price all multiplied by the number of options.

A company’s most recent 10k contains information about all of the current options outstanding. Normally there are multiple options with different strike prices that need to be calculated.

If-Converted Method
The if-converted method is used to calculated the share impact of convertible securities by determining how many new shares would be issued if an in the money convertible is exercised. The end calculation in this process is to multiply the number of securities being exercised by the conversion ratio to determining the new shares.

Also, convertible debt that is converted eliminates interest expense. The after tax interest savings from the conversion is therefore added to earnings per share when calculating the diluted earnings per share.

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