Fully Diluted EPS

This is the company headquarters for Beef in a Can, the meat industry’s answer to EZ Cheese. Ok, so the earnings number came in just fine at $1.12 a share. It's about what the Street was expecting. But then why did the stock sell off hard in the aftermarket? The stock was $35.52 at the close and now it’s at $33.20. Not a huge break, but 6 percent is 6 percent.

So...what gives?

Well, the primary earnings number was good; it beat Street expectations. But the fully diluted earnings per share...well…they sucked. Why? Because the company had granted too many stock options to its employees. There’s a super competitive environment in Silicon Valley to hire engineers, so, yes...in very Wall Streety irony, the company, in trying to be generous with its employees, and be competitive…killed their stock. Where’s the beef, indeed.

Well, those stock option grants were recognized by investors, and those “generous grants” ended up costing the employees and all the shareholders meaningful money as the stock price sagged.

Huh? How’d that work? What happened?

Well, there are primary shares that comprise the base of a company’s ownership. They are the common shares of the company and actually owned...that is, they aren’t options. So Beef in a Can has 100 million shares outstanding, of common shares. But it surprised Wall Street to learn that the company now also had 12 million options outstanding.

And as the company earned $112 million, then yes, they had net income or earnings per share of a dollar twelve for their primary earnings. But their fully diluted earnings are divided by the 100 million common plus the 12 million options, and that calculation is made by dividing the $112 million in earnings by the conveniently numbered 112 million fully diluted shares and options, to get only a dollar a share in fully diluted EPS.

Why is that such a problem? Well…dilution is a bad thing if you’re an already-owning-owner of a company.

Your ownership pie gets spread out over more and more mouths to feed, and you get less fat. So when Wall Street sold off the stock on this earnings surprise, the actual printed number was just fine. It was the denominator…the total dilution of option grants...that beat up the stock.

And yeah, if you’re the CEO of this company, you might, uh…have a beef with that.