Business, Legal & Accounting Glossary
Diluted share is a term used in reporting earnings per share, as in “earnings per diluted share.” Under Statement of Financial Accounting Standards 128, a company that has a complex capital structure (ie, it has securities that have the potential of becoming common shares) must report earnings on both a “basic” (non-dilutive) and diluted share basis. Computing earnings on a dilutive share basis involves consideration of three types of securities: options and warrants, contingent shares, and convertible securities. These securities are assumed to be exercised, issued, or converted, which increases the weighted average of outstanding shares upon which diluted share earnings are computed. Since earnings on a diluted share basis assume more outstanding shares, diluted share earnings are smaller than basic earnings per share. Thus earnings on a diluted share basis is the more conservative presentation.
DIlution of a share is like the Federal Reserve printing more money without taking some out of circulation.
If a company is worth $10 million and it has issued 1 million shares then each share is worth $10. If the company creates another 1 million shares then the previously issued share are suddenly worth half as much, $5.00. $5.00 times 2 million shares = $10 million.
Buying back shares is like reverse dilution, every existing share is now worth more.
Dilution can happen in different ways.
The issue of convertible preferred shares, which are not counted in undiluted shares until they are converted to common stock. It may be good to know if there are a lot of unconverted preferred shares sitting on someone’s shelf.
Compensation of the executives can be in the form of stock options – the executives are given the option of taking some stock at a time of their choosing, and according to some rules which may be incentives for performance, etc. When the options are exercised the total number of shares is increased thus the share of all are diluted.
If the incentive is effective, then the share price the market will pay may have risen sufficiently to compensate for the dilution.
It is smart to know the diluted share price of a company’s stock. It is not immediately apparent when looking at the current market price which is a measure of undiluted share price.
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This glossary post was last updated: 5th August, 2021 | 0 Views.