If-Converted Method
Categories: Derivatives
What would have happened if Mary I had turned England back into a Catholic country? What if Charles Martel had lost the Battle of Tours? What if Tom Cruise had talked Madonna into being a Scientologist during the 1990s? All important "if-converted" questions.
There's also a connotation related to finance. It involves convertible securities.
Convertible securities allow the holder to exchange one form of financial instrument for shares of stock. You own a convertible bond paying 6% interest with a 5-year maturity. Under certain circumstances, you can also turn the bond into 1,000 shares of common stock.
That situation describes the type of "conversion" we're talking about here (sorry, Mr. Cruise). Meanwhile, companies report some of their financial results on per-share basis. In fact, the chief statistic for determining a company's financial health is often its earnings per share, or EPS.
Generally, the math behind EPS is pretty simple. Take the firm's net earnings. Then divide that figure by the number of shares outstanding. The result: earnings per share.
However, that second number (the shares outstanding) gets muddled by convertible securities (among other things, like stock options). As it stands now, those shares don't exist. So they wouldn't get counted in the EPS figure. However, they could exist at any time, especially if the convertible securities are in the money (the stock price set forth for conversion is below the current market price for the stock, making it profitable for someone to exercise the option).
Let's take a slight detour to give an example of the type of conundrum we're talking about. You win the lottery and you want to share the winnings with your family. So that no one feels bad, you want to give every member of the family the same amount. You have your parents, your brother, your brother's wife and their two kids.
However, your sister-in-law is currently pregnant. How should you split up the money? Does the kid currently in utero count? Right now the split would take place between 6 people (your mom, your dad, your brother, your sister-in-law, and each of their two currently air-breathing kids). But that third child will be here soon.
If you use the if-converted method, you'd count that third kid.
The if-converted method considers what would happen if the company's applicable convertible securities were turned into stock. It provides an EPS figure taking into account what would happen if those shares were created.
Usually, companies will provide two EPS figures. One includes just the currently outstanding stock. The other, usually called "diluted EPS," describes what EPS would look like if all the conversions and stock options and other stock-creation devices were exercised.
Investors usually look at the diluted EPS figure as the definitive judge of the firm's earnings situation.
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Finance: What Are Shares Outstanding?268 Views
Finance a la shmoop what are shares outstanding Okay first
things first this is not a qualitative assessment of shares
shares maybe bad awful mediocre good or even outstanding but
that's not what this term refers to it also doesn't
mean that they're you know out standing in the ring
paying dividends in the way that they don't do that
Sorry won't sing again Alright rather shares outstanding is a
technical term that reflects how many pieces make up the
sum total of the ownership pie of a company So
here is what baby's first chainsaw dot com looks like
it has forty million slices and is currently trading for
fifteen bucks a slice while new toddlers were so into
mechanical power tools or how sick and twisted the writers
it's from up Are you been here anyway If you
didn't catch the cleverness here a slice equals a share
so the company has forty million shares outstanding They're trading
at fifteen bucks age and that gives the company a
market value of six hundred million dollars That means that
if someone wanted to buy the entire pie they could
in theory pay six hundred million bucks assuming everyone would
Sell them all their shares for fifteen bucks each and
the shares outstanding Change Sure Bunch of factors change that
number all the time When an employee decides to either
buy out or sell the stock options granted to her
when she joined the company Well those options convert into
shares So if she had ten thousand options and sold
them the company would have then ten thousand fewer options
outstanding We're kind of like a liability but it would
now have forty million ten thousand shares outstanding The options
just converted into shares on men Okay what if the
company wanted to raise thirty million bucks to buy a
small competitors for all cash Well it could sell to
the public two million shares at fifteen bucks a pop
Did it already own those shares Well likely not They
weren't just sitting in the vault in treasury stock so
it had to print those shares out of thin air
to dot and then sell them to new buyers So
add two million to the total and now the company
has forty two million ten thousand shares outstanding It also
has thirty million bucks more in cash on its balance
Sheet by the way now there's a danger in the
increase in shares outstanding It's called share creep and it's
not this guy Rather it refers to the gradual increase
in shares outstanding otherwise known as dilution because now instead
of a six hundred million dollar valuation with forty million
shares at fifteen bucks the company if it were to
still have a six hundred million dollar valuation now it's
more shares outstanding would see its stock price drop teo
six hundred million divided by forty two million ten thousand
and yeah that gets you fourteen dollars in twenty eight
cents a share So in the process of the options
being converted and the cash being raised by selling equity
the company destroyed seventy two cents a share in value
Now in real life the market probably goes up and
makes account for all that What were omitting here is
that the company raised thirty million bucks of cash in
the process Cash that well we investors presume it will
use wisely and not on you know kibble for the 00:03:14.07 --> [endTime] office terrier