Which Shares Outstanding Should I Use In My Valuation?
Every quarter companies report several variations of their shares outstanding which can create some confusion when valuing a company. There are 4 shares outstanding figures typically reported each period in a financial statement. They are:
- Basic shares outstanding
- Diluted shares outstanding
- Parenthetical shares outstanding
- Shares outstanding on the filing preparation date
Basic Shares Outstanding
Basic shares outstanding reflects the weighted average number of shares issues and outstanding for that income statement period. The figure is used to compute basic earnings per share and does not reflect the impact of dilutive securities such as stock options, warrants or convertible securities. Each period on the company’s income statement will have its own basic shares outstanding figure for that specific period.
Diluted Shares Outstanding
Diluted shares outstanding reflects the impact of any potentially dilutive securities on basic shares outstanding for computing diluted earnings per share on the income statement. For example, if a company’s stock price is at $50 and it has issued employees stock options to purchase its shares at $25, these in-the-money options will be reflected in the diluted shares outstanding as if they we excercised. This is typically done using an approach called the treasury method which effectively assumes that all in-the-money options are excecised on a cashless basis. If reported, diluted shares outstanding will always be equal to or greater than basic shares outstanding.
Parenthetical Shares Outstanding
Most companies also report the number of shares outstanding in the equity section of the balance sheet. These figures are as of the specific balance sheet dates whereas the basic and diluted shares outstanding are calculated as weighted averages for the income statement period. They represent the actual shares outstanding and do not account for any dilution adjustments.
Shares Outstanding On Filing Preparation Date
Companies filing with the SEC are required to publish the actual shares outstanding on the date their filing was prepared. This figure is typically calculated a few days before the actual filing with the SEC so it is often more current than the shares outstanding used in the face financials which may be 30 to 75 days older. Like the parenthetical shares outstanding, these figures do not account for any dilution adjustments.
Which Shares Outstanding Figure Should I Use?
Most market participants use diluted shares outstanding to calculate the market value of a company’s equity because it reflects the potential impact of dilutive securities. Using basic shares outstanding creates the potential issue of not accounting for a large number of additional shares that are likely to be issued. For example, if a company has 1 million employee stock options that are in-the-money, these shares would almost certainly be exercised if the company was sold at today’s market price. Excluding these shares from the analysis will be overstating the value received from such a sale.
Since the basic and diluted shares outstanding figures represent weighted averages for the income statement periods, there may be several different versions to choose from. This is because companies report an income statement for both the quarter and year-to-date periods in their 2nd and 3rd quarter filings. For companies with active share buyback or stock option activity, the difference between the quarterly and year-to-date figures can be material. In general, the quarterly shares outstanding figure will always be the most accurate since it represents the least averaging or smoothing.
However, this presents an interesting issue for annual (10-K) filings since the basic and diluted shares outstanding figures are weighted averages for the entire year. The annual figures may be smoothing out significant changes throughout the year. To avoid this smoothing out, you should use the average shares outstanding figure for the 4th quarter and not the full year. Since companies do not disclose their 4th quarter income statement (only annual figures are presented) 4th quarter shares outstanding figures are not a required disclosure so it usually needs to be computed.
Computing 4th Quarter Diluted Shares Outstanding
To compute diluted shares outstanding for the 4th quarter we need two figures: 4th quarter net income and 4th quarter diluted earnings per share. These figures may be found in the footnotes or they may be computed. Here is how they are computed:
4th Quarter Net Income = Annual Net Income – Net Income For The First 3 Quarters
4th Quarter Diluted Earnings Per Share = Annual Diluted Earnings Per Share – Diluted Earnings Per Share For the First 3 Quarters
Once these figures are calculated, the final step is:
4th Quarter Diluted Shares Outstanding = 4th Quarter Net Income / 4th Quarter Diluted Earnings Per Share
Note: Be sure to check the earnings per share footnote since the income statement may not include all of the items used to arrive at net income for the earnings per share calculation.
At TagniFi, we automatically compute 4th quarter diluted shares outstanding in ourTagniFi Fundamentals dataset. This data is available in our Excel Add-In or our API. This saves our clients time and effort in computing the most accurate shares outstanding data for their valuations.