Fully diluted shares are the number of shares of stock that a company would have outstanding if all options were exercised and bonds converted. Companies often refer to their profits or earnings on a fully diluted basis, which means that they divide the profits or earnings by the number of fully diluted shares.
A potential investor should look at the number of fully diluted shares when making comparisons between companies. Even if the number includes options that have not been exercised, or bonds that have not been converted, it factors in those possibilities. If an investor only looks at the number of shares actually outstanding, a large number of exercised options or bond conversions could cause a sharp drop in the share price by essentially flooding the market with new shares.
As an example, assume a company has 10 million shares outstanding at $10 per share. The company’s market capitalization is $100 million, or 10 million shares times $10 each. Suppose there are also 3 million options that have not been exercised, plus bonds equal to 2 million shares when converted. If all 5 million of these shares were exercised, the company would have 15 million shares outstanding, but still have a market capitalization of $100 million, so each share would be worth just $6.67.