For a long time, it was considered standard to include only the number of options and dilutive securities that are exercisable in the calculation of diluted shares, as opposed to outstanding.
Insider’s Tip: Exercisable vs Outstanding OptionsĬompanies oftentimes disclose both their “outstanding” and “exercisable” options since certain outstanding options will have yet to vest. The assumption here is that the company would repurchase its shares in the open market in an effort to reduce the net dilutive impact. In the subsequent step, the TSM assumes the entirety of the proceeds from the exercising of those dilutive options goes towards repurchasing stock at the current market share price. Note that only the securities deemed “in-the-money” are assumed to have been exercised, therefore those “out-of-the-money” are not included in the new share count. In terms of the steps involved in the TSM, first, the number of in-the-money options and other dilutive securities are summed up and that figure is then added to the number of basic shares outstanding.
The reason is that the denominator (the share count) has increased whereas its numerator (net income) remains constant. That said, if a company has issued such securities in the past (i.e., the potential for conversion), its diluted EPS in all likelihood is going to be lower than its basic EPS. “In-the-Money” Options ➝ Strike Price Current Share Priceįurthermore, the EPS formula divides the net income of a company by its share count, which can be either on a basic or diluted basis.If disclosed, options are evaluated on a tranche-by-tranche basis to determine if they are “in the money.”Įach tranche has a strike price, which the option holder must pay in order to exercise the option as part of the contractual agreement. Restricted Stock Units (RSUs): Issued to the company’s management team with a convertible feature attached.Warrants: Similar financial instruments to options but result in the issuance of new shares if exercised.Here, the number of shares repurchased is equal to the option proceeds (the number of gross “in-the-money” dilutive securities multiplied by the strike price) divided by the current share price.īesides options, other examples of dilutive securities include warrants and restricted stock units (RSUs). Net Dilution = Gross “In-the-Money” Dilutive Securities – Shares Repurchased.The formula for the total diluted share count consists of all basic shares, as well as the new shares from the hypothetical exercise of all in-the-money options and conversion of convertible securities. Treasury Stock Method Formula (“If Converted”) The exclusion of these types of securities into common equity would mistakenly inflate the earnings per share (EPS) figure. Hence, the fully diluted shares outstanding count is a relatively more accurate representation of the actual equity ownership and equity value per share of a company. Unlike the calculation of the basic share count and coinciding basic earnings per share (EPS), metrics based on diluted shares outstanding also consider a company’s dilutive securities such as options, rather than just the basic shares. The treasury stock method approximates what a company’s earnings per share (EPS) would be under the assumption that its dilutive securities, such as options, are exercised.Īnother key assumption inherent to the TSM is that the (typically cash) proceeds from the exercising of these dilutive securities (i.e., option proceeds) are then used to repurchase shares under the belief that a rational company would attempt to mitigate the dilutive impact of the options by doing so. Under the TSM approach, the total diluted share count takes into account the new shares issued by the exercising of options and other dilutive securities that are “in-the-money” (i.e., the current share price is greater than the exercise price of the option/warrant/grant/etc.).
Tanzu Portfolio Sessions at VMworld 2021.Key links to learn more about VMworld 2021:.
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