Economic outstanding shares

What Is Economic Outstanding Shares?

Economic outstanding shares represent the total number of a company's shares that would be in circulation if all potential dilutive securities were converted into common stock. This figure goes beyond just the currently issued and held shares, aiming to provide a comprehensive view of a company's full capital structure, a key aspect within corporate finance. While standard outstanding shares reflect the actual shares held by investors, economic outstanding shares incorporate all equity instruments that could potentially become common stock, such as convertible bonds, stock options, and warrants. Understanding economic outstanding shares is crucial for stakeholders to assess the true extent of potential dilution and a company's overall equity base.

History and Origin

The concept of tracking a company's total share count, including potential additions, evolved with the increasing complexity of corporate financing and compensation structures. Early business entities, such as the joint-stock company of the 17th century, primarily dealt with a straightforward issuance of shares to raise capital for ventures like colonial expeditions. As financial markets matured, companies began using various instruments beyond simple common stock to raise funds or incentivize employees.

The proliferation of convertible securities and employee stock options in the latter half of the 20th century highlighted the need for a more comprehensive measure of shares that could potentially be outstanding. Regulators, including the U.S. Securities and Exchange Commission (SEC), recognized this need to ensure investors received a complete picture of a company's per-share financial performance. Staff Accounting Bulletin (SAB) No. 98, issued by the SEC in 1998, updated existing guidance to align with new accounting standards related to earnings per share, implicitly emphasizing the importance of considering potential common stock issuances.³

Key Takeaways

• Economic outstanding shares provide a comprehensive view of a company's total share count, including all currently issued shares and potential shares from convertible securities.
• This metric is critical for evaluating potential dilution and its impact on per-share metrics.
• It includes instruments like convertible bonds, stock options, warrants, and restricted stock units.
• Analysts use economic outstanding shares to calculate a more conservative and forward-looking earnings per share.

Formula and Calculation

The calculation for economic outstanding shares involves starting with the basic number of shares currently outstanding and adding all shares that would be issued if dilutive securities were exercised or converted.

Where:

• Basic Shares Outstanding: The number of shares currently held by all shareholders, excluding treasury stock.
• Shares from Convertible Debt: Shares that would be issued if all convertible bonds or other convertible debt instruments were converted into common stock.
• Shares from Stock Options: Shares that would be issued if all exercisable employee stock options were exercised.
• Shares from Warrants: Shares that would be issued if all outstanding warrants were exercised.
• Shares from Restricted Stock Units (RSUs): Shares that would be issued upon the vesting period of RSUs.

This formula accounts for the full potential dilutive impact of a company's capital structure on its shareholder equity.

Interpreting the Economic Outstanding Shares

Interpreting the economic outstanding shares figure provides a deeper understanding of a company's true equity base and potential future share count. A significant difference between a company's basic shares outstanding and its economic outstanding shares indicates a substantial potential for dilution. This is particularly relevant when analyzing companies that frequently use equity compensation or issue convertible debt.

A higher number of economic outstanding shares compared to basic shares outstanding implies that future earnings per share calculations, based on actual shares in circulation, could be lower once these dilutive securities are converted. Investors often use this expanded share count to perform "fully diluted" analyses, providing a more conservative estimate of per-share metrics and the overall impact on existing shareholders. It helps in assessing the long-term impact on ownership percentage and the value of each share.

Hypothetical Example

Consider "Tech Innovations Inc." with the following equity components:

• Basic Shares Outstanding: 100 million shares
• Outstanding Employee Stock Options: 10 million shares (all exercisable)
• Convertible Bonds: Can be converted into 5 million shares
• Warrants: Can be exercised for 2 million shares

To calculate Tech Innovations Inc.'s economic outstanding shares, we add these components:

Economic Outstanding Shares = 100 million (Basic) + 10 million (Options) + 5 million (Convertible Bonds) + 2 million (Warrants)
Economic Outstanding Shares = 117 million shares

If Tech Innovations Inc. reported a net income of $117 million, its basic earnings per share would be $1.17 ($117 million / 100 million shares). However, considering the economic outstanding shares, the fully diluted earnings per share would be $1.00 ($117 million / 117 million shares). This example illustrates how economic outstanding shares present a more conservative view of profitability on a per-share basis, factoring in all potential new shares.

Practical Applications

Economic outstanding shares are widely used in financial analysis and valuation, especially within the context of publicly traded companies.

• Valuation Models: Financial analysts frequently use economic outstanding shares when performing discounted cash flow (DCF) models or other valuation methodologies to arrive at a per-share value that accounts for all potential dilution.
• Mergers and Acquisitions: During mergers or acquisitions, understanding the full economic outstanding shares of the target company is vital for accurate valuation and to determine the true cost per share for the acquiring entity.
• Regulatory Filings: Public companies are required by regulatory bodies, such as the SEC, to report earnings per share on both a basic and diluted basis in their financial statements. The diluted EPS calculation inherently relies on a figure similar to economic outstanding shares, reflecting potential conversions. The SEC's interim financial statements requirements, for instance, mandate reporting "net income—total and per share" with retroactive adjustments.
  *² Investor Analysis: Investors scrutinize economic outstanding shares to understand the potential impact of future share issuances on their ownership stake and the value of their investment. This is particularly relevant for companies with significant numbers of convertible securities or employee equity plans.
• Corporate Actions: Decisions regarding corporate actions like share buybacks or new share issuances are often made with the context of how they will impact the economic outstanding shares and subsequent per-share metrics. For example, a company might conduct a share buyback to reduce its outstanding shares and thereby improve its earnings per share, as demonstrated by companies like Citigroup.

¹## Limitations and Criticisms

While economic outstanding shares provide a more comprehensive picture than basic outstanding shares, they come with certain limitations and criticisms. One primary critique is that the calculation assumes the conversion or exercise of all dilutive securities, which may not always occur. For instance, stock options might only be exercised if the stock price rises above a certain strike price, or preferred stock might only convert under specific conditions that may not be met. This assumption can lead to a "worst-case scenario" share count that may never materialize.

Furthermore, the methodologies for calculating the dilutive effect, such as the treasury stock method for options and warrants, involve assumptions about the use of proceeds from the exercise, which may not perfectly reflect real-world scenarios. Critics argue that overly complex dilution calculations can obscure the underlying operational performance of a company by focusing on hypothetical scenarios. While important for a conservative view, it is essential for analysts and investors to consider the probability of conversion for various dilutive instruments and not solely rely on the maximum potential dilution.

Economic Outstanding Shares vs. Fully Diluted Shares

The terms "economic outstanding shares" and "fully diluted shares" are often used interchangeably in financial contexts, both referring to the total number of common shares that would be in existence if all outstanding convertible securities were converted or exercised. Both concepts aim to capture the maximum potential share count for a company, thus providing a more conservative and comprehensive basis for per-share calculations compared to basic shares outstanding. The primary confusion arises when differentiating these from simply "outstanding shares," which only count shares currently held by investors. While "outstanding shares" is a snapshot of current shares, both "economic outstanding shares" and "fully diluted shares" provide a forward-looking perspective, incorporating the impact of items like stock options, warrants, and convertible debt, thereby painting a fuller picture of a company's total equity base.

FAQs

What is the primary difference between economic outstanding shares and basic outstanding shares?

Basic outstanding shares refer to the actual number of shares currently held by investors. Economic outstanding shares, also known as fully diluted shares, include these basic shares plus all additional shares that would be created if all convertible securities, such as stock options or convertible bonds, were converted into common stock.

Why is it important for investors to consider economic outstanding shares?

Considering economic outstanding shares provides investors with a more conservative and realistic view of a company's per-share metrics, like earnings per share. It highlights the potential impact of future share issuances from dilutive securities on their ownership percentage and the value of their investment.

Do all companies report economic outstanding shares?

Publicly traded companies are generally required by regulatory bodies to report both basic and diluted earnings per share in their financial statements. The diluted earnings per share calculation inherently uses a share count similar to economic outstanding shares, factoring in potential dilution from various instruments.

Are economic outstanding shares always higher than basic outstanding shares?

Yes, economic outstanding shares will always be equal to or higher than basic outstanding shares. They are only equal if a company has no dilutive securities outstanding that could be converted into common stock.