Shares Outstanding and Dilution

Shares Outstanding and Dilution

Very often a company does not have the credit line to be able to issue long term debt. To raise capital they would issue shares instead. This is a great method to avoid loading up the interest cover charge but the negative is that it causes dilution. This means that for every dollar that the company earns will spread out to more shareholders. For investors who want to calculate ratios on an historical basis it is very important to adjust the ratios to account for dilution. Very often one would track historical P/E but one has to be aware that many employees are awarded with stock options when exercised will dilute the total shares outstanding. This means that a conservative investor will calculate EPS by dividing the total net income by shares outstanding + securities with the potential to be converted into equity (multiplied by the conversion ratio). This will provide the fully diluted EPS. Compare the growth in the shares outstanding in the past 10 years. If the figure has been growing appropriate adjustments need to be made.