When people use the terms “diluted shares” or “undiluted shares,” they are generally speaking about a publicly held company’s earnings per share. Diluted and undiluted earnings both provide snapshots of a company’s financial health. Briefly, undiluted earnings per share tell you how the company is doing today, just as things are. Diluted earnings per share offer a worst-case scenario -- what the company’s stock would look like if the company had to immediately issue every share it had promised in stock options or convertible bonds.
The term “outstanding shares” means all shares of stock in publicly traded company that are held by investors -- including officers, insiders and the public. It does not include any shares that the company has repurchased. The number of shares of outstanding stock is used to calculate basic earnings per share, or EPS.
Undiluted Earnings Per Share
A company’s undiluted earnings per share is calculated by dividing the company’s annual profit by its number of outstanding shares. A company with $1 million in profit and 1 million shares of outstanding stock has an EPS of $1.
Fully Diluted Earnings Per Share
To calculate fully diluted earnings per share, divide the company’s profit by the total number of outstanding shares plus all of the shares the company would have to issue if everyone with a stock option or convertible bond traded them in for stock. If a company with $1 million in profit and 1 million shares of stock outstanding had promised another 1 million shares in options and bonds, its fully diluted earnings per share would be 50 cents.
The price-earnings ratio, or P/E ratio, is a popular way to compare company values. It is calculated by dividing the price of one share of stock by the company’s fully diluted earnings per share. If stock in a company with a diluted EPS of 50 cents is selling for $5 a share, its P/E ratio is 10-to-1. If a company has a high P/E ratio, that could be a sign that investors believe it will grow in the future -- their demand has raised the price of the stock before earnings have caught up.
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