Sunday, 5 February 2012

Dilution of Earnings

When considering a company's earnings per share history, make certain the numbers are adjusted for changes in capitalization; that is, work from fully diluted numbers. 

Be sure that all shares that have been authorized for issuance by the board of directors are added into the number of shares outstanding.    Newly issued shares, split shares, and shelf registration (shares sitting in the company's vault but not yet issued) must be put in the pot.

This admonition applies not only to the most current earnings but to any earnings from the past that are used for comparison.  The easiest way to make the adjustment when new shares are authorized is to work backward.  Compute earlier earnings as if the new shares, rights, warrants, privileges, options, and so on already have been exercised.  Corresponding changes should be made to book value and current asset value per share.

Fortunately, most companies include adjustments for shareholders in their financial statements, reporting figures on a fully diluted basis.  But sometimes not.  This is why shareholders must be wide awake when comparing earnings from one year to another, always work from fully diluted earnings.

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