How to Calculate Fully-Diluted Market Capitalization

Investors must consider the effects of dilution on share price.
Investors must consider the effects of dilution on share price. (Image: Comstock/Comstock/Getty Images)

A company's market capitalization is the total value of its outstanding stock. The fully-diluted market capitalization equals the expected future market capitalization if all financial instruments that can be converted into stocks are fully utilized. Full dilution occurs when all convertible bonds and warrants issued by the firm are exchanged for stock, and the number of outstanding shares reach the upper limit of what is possible within the existing financial structure of the firm.

Find out the number of shares that will be issued if all convertible instruments issued by the firm are exercised. Convertible instruments include, options, convertible bonds and warrants issued by the firm. Options allow the holder to buy a predetermined number of shares at a specific price, while warrants give essentially the same right to the holder. Convertible bonds are borrowing instruments that can be converted into stock at a predetermined ratio, such as 100 shares for each bond with a face value of $1,000. Add the total number of shares that will be created as a result of full utilization of all convertible instruments to the existing number of shares. This is the fully-diluted share count.

Find a representative market price for the firm's shares. If the firm's stock is publicly traded, you can obtain the most recent price from any finance portal such as Yahoo! Finance. If, you are dealing with a privately held corporation, you need to find public companies that operate in the same industry and produce similar levels of annual income to use as a benchmark. Another method when dealing with private corporations is to find recent private transactions where shares have changed hands. This can be challenging as neither the shareholder nor the firm must make such information public. If you have close ties to the firm, you may be able to find out at what price shares recently changed hands.

Multiply the number of fully-diluted shares by the stock price to arrive at the firm's fully-diluted market capitalization. This is the theoretical total market value of the firm under full dilution. Remember two points when analyzing this figure. First, full dilution occurs very rarely, as at least some of the options or convertible bonds are not converted before their expiration. Second, if full dilution occurs, the number of shares will significantly increase, thereby making shares potentially less valuable. The laws of supply and demand dictate that flooding the market with new shares will likely drive their average price down. The fully-diluted market capitalization is therefore more of a theoretical exercise and must be used with caution in financial forecasts.

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