Diluted Shares vs Outstanding Shares What’s the Difference

Shares of a company can be categorised in various ways depending on ownership and potential future issuance. Two important terms often discussed in stock market investing are outstanding shares and diluted shares. While both relate to the number of shares a company has, they have different implications for shareholders and valuation.

This article explains what outstanding shares and diluted shares mean, how they differ, and why investors should be aware of both when evaluating a company.

Outstanding shares refer to all the shares currently held by shareholders, including institutional investors, retail investors, company insiders, and restricted shares. These shares represent actual ownership in the company and are used to calculate metrics like earnings per share (EPS) and market capitalisation.

Diluted shares consider not only the shares currently held but also all additional shares that may be created if all convertible financial instruments, such as employee stock options, warrants, convertible bonds, and preferred shares, are exercised or converted into common equity.

The conversion of these instruments increases the total share count, which can decrease the ownership percentage of current shareholders. As a result, diluted shares provide a broader perspective of the company’s total equity, which is important for understanding potential impacts on valuation and shareholder influence.

The table below highlights the key differences between outstanding shares and diluted shares, helping to clarify their distinct roles in ownership, earnings calculations, valuation, and shareholder influence:

Understanding diluted shares is important for several reasons:

• Dilution of Ownership: When convertible securities are exercised, the total number of shares increases, which reduces the ownership percentage of existing shareholders. This can affect voting power and influence in company decisions.
  

• Impact on Earnings Per Share (EPS): Diluted EPS takes into account the potential increase in shares, offering a more conservative and realistic measure of the company’s profitability. It helps investors see how earnings could be affected if all options and convertibles become shares.
  

• Valuation Accuracy: Considering diluted shares gives a clearer view of market capitalisation and valuation by factoring in the possible expansion of shares outstanding, which affects the value of each individual share.

To calculate diluted shares, you add the total outstanding shares to the number of additional shares that would be created if all convertible securities were exercised. One widely used approach is the Treasury Stock Method, that supposes that the company uses the proceeds from exercising options or warrants to repurchase shares at the current market price. This approach helps avoid overestimating the extent of dilution.

Consider a company with 1 million outstanding shares and 100,000 stock options granted to employees. If all these options were exercised, the company would issue new shares, increasing the total shares outstanding to over 1.1 million, thus diluting current shareholders’ stakes.

Investors should pay attention to diluted shares for several reasons:

• Informed Decision-Making: Awareness of dilution helps investors evaluate potential risks to ownership and earnings accurately.
  

• Comparing Companies: Diluted shares allow for a more consistent comparison of profitability and valuation metrics across companies that may have differing levels of convertible securities.
  

• Assessing Equity Incentives: It helps investors understand how employee stock options and other incentives could affect the total number of shares and the company’s capital structure in the future.

Outstanding shares and diluted shares are both crucial metrics for investors to assess ownership structure and valuation. While outstanding shares reflect current ownership, diluted shares offer insight into potential changes due to convertible securities. Understanding both helps investors make better-informed investment decisions.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.