What Is Adjusted Future Outstanding Shares?
Adjusted Future Outstanding Shares, more commonly known as Fully Diluted Shares Outstanding, represents the total number of a company's shares that would be in circulation if all exercisable and convertible securities were converted into Common Stock. This metric belongs to the broader category of Corporate Finance and is a critical component in Financial Reporting and valuation analysis. It provides a more conservative view of a company's equity base by accounting for potential future dilution from various sources.
Unlike Basic Shares Outstanding, which only considers shares currently held by Shareholders, Adjusted Future Outstanding Shares anticipates the maximum possible number of shares. This includes the conversion of financial instruments such as Stock Options, Warrants, Convertible Bonds, and Preferred Stock into common shares. The inclusion of these potential shares provides a more comprehensive picture of a company's true equity structure, which is vital for calculating metrics like Earnings Per Share (EPS).
History and Origin
The concept of accounting for potential future shares emerged with the increasing complexity of corporate capital structures, particularly the widespread use of equity compensation and convertible securities. Before standardization, companies had varied approaches to reporting the impact of these instruments, leading to inconsistencies in financial analysis.
A significant push for clearer reporting came from accounting bodies. In the United States, the Financial Accounting Standards Board (FASB) introduced guidelines to ensure that the dilutive effect of these securities was properly recognized. Specifically, Accounting Standards Codification (ASC) Topic 718, "Stock Compensation," formalized how companies should expense equity awards, including stock options, on their Income Statement. This standard, which superseded FAS 123(R), requires companies to recognize compensation expense for equity awards over their vesting period based on fair values.5 This evolution in accounting standards has directly influenced the robust calculation and reporting of Adjusted Future Outstanding Shares in financial disclosures. Public companies are required to report both basic and diluted shares in their filings, such as the Form 10-K, providing transparency on potential dilution.4
Key Takeaways
- Adjusted Future Outstanding Shares, or fully diluted shares, includes all potential shares that could be created from dilutive securities.
- It offers a more conservative and complete view of a company's equity base, reflecting maximum potential Dilution.
- This metric is crucial for calculating diluted Earnings Per Share (EPS), a key indicator of profitability for investors.
- Common dilutive instruments include stock options, warrants, convertible debt, and convertible preferred stock.
- Companies report Adjusted Future Outstanding Shares in their financial statements as part of regulatory requirements.
Formula and Calculation
The calculation of Adjusted Future Outstanding Shares involves adjusting the basic shares outstanding for the impact of all dilutive securities. The primary methods used are the Treasury Stock Method for options and warrants, and the "If-Converted Method" for convertible debt and preferred stock.
1. Treasury Stock Method (for Stock Options and Warrants):
This method assumes that any proceeds from the exercise of "in-the-money" options or warrants would be used by the company to Share Buyback its own shares from the open market.
Only options or warrants where the exercise price is less than the average market price of the common stock are considered "in-the-money" and thus dilutive.
2. If-Converted Method (for Convertible Bonds and Convertible Preferred Stock):
This method assumes that convertible securities are converted into common stock at the beginning of the reporting period (or date of issuance, if later).
For convertible debt, the interest expense (net of tax) associated with the converted debt is also added back to net income when calculating diluted EPS, as it would no longer be an expense if converted.
Total Adjusted Future Outstanding Shares:
Interpreting the Adjusted Future Outstanding Shares
Interpreting Adjusted Future Outstanding Shares primarily revolves around assessing the potential for Dilution and its impact on per-share metrics, most notably Earnings Per Share (EPS). A higher number of Adjusted Future Outstanding Shares compared to basic shares outstanding indicates a significant potential for dilution, which can reduce EPS and subsequently impact a company's stock valuation.
Financial analysts use this metric to perform a more conservative valuation of a company's equity. When comparing companies, particularly those with complex capital structures involving numerous stock options or convertible securities, using Adjusted Future Outstanding Shares provides a more "apples-to-apples" comparison of their true profitability on a per-share basis. It helps investors understand the maximum potential impact on their ownership percentage if all outstanding dilutive securities were exercised. This insight is critical for making informed Investment Decisions.
Hypothetical Example
Consider "Tech Innovations Inc." with the following details for the current fiscal year:
- Basic Shares Outstanding: 10,000,000 shares
- Average Market Price of Common Stock: $50.00 per share
- Employee Stock Options: 1,000,000 options with an exercise price of $40.00 per option
- Convertible Bonds: $5,000,000 face value, convertible into 100 shares of common stock per $1,000 bond.
Step 1: Calculate Net Dilutive Shares from Stock Options (Treasury Stock Method)
The options are in-the-money since the exercise price ($40) is less than the market price ($50).
- Shares created from options: 1,000,000 shares
- Proceeds from exercise: (1,000,000 \text{ shares} \times $40.00/\text{share} = $40,000,000)
- Shares repurchased with proceeds: ($40,000,000 / $50.00/\text{share} = 800,000 \text{ shares})
- Net dilutive shares from options: (1,000,000 - 800,000 = 200,000 \text{ shares})
Step 2: Calculate New Shares from Convertible Bonds (If-Converted Method)
- Number of bonds: ($5,000,000 / $1,000/\text{bond} = 5,000 \text{ bonds})
- New shares from conversion: (5,000 \text{ bonds} \times 100 \text{ shares}/\text{bond} = 500,000 \text{ shares})
Step 3: Calculate Adjusted Future Outstanding Shares
- Adjusted Future Outstanding Shares = Basic Shares Outstanding + Net Dilutive Shares from Options + New Shares from Convertibles
- Adjusted Future Outstanding Shares = (10,000,000 + 200,000 + 500,000 = 10,700,000 \text{ shares})
In this hypothetical example, Tech Innovations Inc. has 10,700,000 Adjusted Future Outstanding Shares, reflecting the potential Equity dilution from its outstanding stock options and convertible bonds.
Practical Applications
Adjusted Future Outstanding Shares is a fundamental metric with several practical applications across finance and investing:
- Earnings Per Share (EPS) Calculation: The most direct application is in calculating diluted EPS, a widely reported profitability metric. Public companies are mandated to report both basic and diluted EPS in their Financial Statements, typically found in their 10-K and 10-Q filings with the U.S. Securities and Exchange Commission (SEC).3 For instance, a company's 10-K report will detail its basic and diluted share counts, which directly impact the reported EPS figures.2
- Financial Modeling and Valuation: Analysts use Adjusted Future Outstanding Shares in detailed Financial Modeling to project future earnings and construct more conservative valuation models. This is crucial for discounted cash flow (DCF) analysis or comparable company analysis, ensuring that the potential impact of dilution is factored into the intrinsic value assessment of the company's Securities.
- Mergers and Acquisitions (M&A) Due Diligence: During M&A transactions, the acquiring company performs thorough Due Diligence. Understanding the Adjusted Future Outstanding Shares of the target company is critical to accurately assess its true equity value and the potential for future dilution, which can affect the deal's economics and the acquiring firm's own share count post-acquisition.
- Capital Structure Analysis: Companies constantly manage their capital structure. The number of Adjusted Future Outstanding Shares helps management and investors understand the full scope of a company's equity obligations and how future exercises or conversions could impact control and ownership. For instance, a company undertaking a Share Buyback program aims to reduce its outstanding shares, which can positively impact EPS and stock price by decreasing the supply of shares.
Limitations and Criticisms
While Adjusted Future Outstanding Shares provides a more comprehensive view of a company's equity, it also has certain limitations and faces criticisms:
- Reliance on Assumptions: The calculation of Adjusted Future Outstanding Shares, especially under the treasury stock method, relies on assumptions about the market price of the stock and the exercise of options. These assumptions may not perfectly reflect real-world scenarios. For instance, the assumption that proceeds from option exercises are used to repurchase shares might not always hold true; companies could use the cash for other purposes, such as investment or debt reduction.
- Complexity and Opacity: For companies with numerous types of dilutive securities and complex vesting schedules, calculating and understanding Adjusted Future Outstanding Shares can be intricate. The methodologies, such as ASC 718 for stock compensation, introduce layers of accounting complexity that may be challenging for non-experts to fully grasp.1
- Potential for Over-Dilution Impression: In some cases, the calculated Adjusted Future Outstanding Shares might present an impression of greater potential dilution than is realistically likely to occur. Not all "in-the-money" options may be exercised immediately, and convertible securities may not be converted if, for example, the equity conversion is not economically favorable for the holder.
- Backward-Looking Nature: The calculation is typically based on historical financial data and current security structures. While it projects future potential, it doesn't account for dynamic market changes or strategic decisions (e.g., new equity issuances or share buybacks) that could alter the actual number of shares outstanding in the future.
Adjusted Future Outstanding Shares vs. Basic Shares Outstanding
The distinction between Adjusted Future Outstanding Shares (often referred to as fully diluted shares outstanding) and Basic Shares Outstanding is crucial for accurate financial analysis.
Feature | Basic Shares Outstanding | Adjusted Future Outstanding Shares (Fully Diluted) |
---|---|---|
Definition | The actual number of common shares currently held by investors. | The total number of shares if all dilutive securities were converted. |
Inclusion | Only shares actively traded and held by investors and insiders. | Basic shares plus shares from stock options, warrants, convertible debt, convertible preferred stock, etc. |
Purpose | Used for calculating basic EPS, dividends, and voting rights. | Used for calculating diluted EPS and for a more conservative valuation. |
Conservatism | Less conservative, reflects current reality. | More conservative, reflects potential future dilution. |
Reporting | Always reported in financial statements. | Also reported, usually alongside basic shares, in financial statements. |
The main point of confusion often arises because basic shares represent the current reality of ownership and control, while Adjusted Future Outstanding Shares provides a "what if" scenario. While dividends and voting rights are typically based on basic shares outstanding, analysts and investors often focus on Adjusted Future Outstanding Shares when evaluating a company's per-share profitability and valuation prospects to account for the full potential impact of dilution.
FAQs
What does "adjusted future outstanding shares" mean in simple terms?
It's a fancy way of saying "fully diluted shares outstanding." It means we're counting not just the shares a company currently has out there, but also all the shares that could possibly be created in the future if certain financial instruments, like Employee Stock Options or convertible bonds, are turned into regular shares.
Why is this metric important for investors?
Adjusted Future Outstanding Shares is important because it gives investors a more complete and conservative picture of how many shares could eventually exist. This impacts metrics like Earnings Per Share. If a company has many potential new shares, its EPS could be lower in the future, which might affect its stock price. It helps investors understand the full potential for Dilution.
Where can I find information about a company's adjusted future outstanding shares?
Publicly traded companies are required to disclose this information in their financial reports, particularly their annual reports (Form 10-K) and quarterly reports (Form 10-Q), filed with the U.S. Securities and Exchange Commission (SEC). You can usually find the basic and diluted share counts in the Notes to Financial Statements or within the "Earnings Per Share" section of the income statement.
Does a high number of adjusted future outstanding shares always mean a bad thing?
Not necessarily. While a higher number implies greater potential dilution, it's essential to consider the context. For instance, many growth companies, especially in the technology sector, use stock options as a key part of Executive Compensation to attract and retain talent. This naturally leads to a higher potential share count. Investors need to assess whether the potential growth and future earnings justify the dilution from these instruments.
How do share buybacks affect adjusted future outstanding shares?
A Share Buyback reduces the number of basic shares outstanding. If a company uses proceeds from exercised options to buy back shares, it reduces the net dilutive effect on Adjusted Future Outstanding Shares, as fewer shares are added to the total count. This can be a strategy to mitigate dilution and enhance per-share metrics.