Dilutive Securities

Dilutive Securities can be defined as a total number of the securities (like stock options, convertible bonds, etc.) that the company has at a particular point in time that can be converted into the normal securities by the holders of such security by exercising the right available with them concerning conversion.

In simple terms, we call the financial instruments dilutive securities if they increase the number of outstanding shares. What does that mean? It means that such securities are those instruments that can easily convert into common shares.

But why do we need to know about such securities?

It has implications when you're calculating fully diluted earnings per share. Due to these securities, the earnings per share can reduce. As a result, investors may not be attracted to investing in the company.

If a company is new in the business, there are a lot of upsides. However, it has a good side as well. The company offers diluted securities with the purpose of conversion. That’s why many investors get attracted to the conversion feature of diluted securities and buy them.

To understand how diluted EPS works, let's look at the formula of diluted earnings per share.

You can see that by considering the diluted securities, the diluted EPS would reduce. It can act as a bane or boon. It depends on how an investor looks at the shares of the company.

• Dilutive securities refer to the total number of the company's securities (such as stock options, convertible bonds, etc.) that can be converted into regular securities by the holders of those securities by exercising the conversion rights that are available to them.
• Options & warrants, convertible bonds, and preferred stocks are dilutive securities.
• Convertible securities businesses use to attract investors have made dilution securities more critical. Diluted earnings per share can always be at most essential EPS. When computing diluted earnings per share, anti-dilutive security is not included if essential EPS is higher than diluted EPS.

#1  - Options & Warrants

Options allow holders to buy the share at a specific price and during a certain period. Generally, companies issue options to their employees.

Warrants are more or less similar to the options the company issues. You can also acquire warrants at a specific price and during a specified period/time. And stock warrants can also be converted into common stocks. The only difference between the warrants and the options is the parties they’re being issued to. The company issues Options to the employees, whereas the company issues warrants to the individuals outside the company.

Have a look at this options table from Colgate's 2014 10K. This table details Colgate's outstanding stock options and its weighted average exercise price.

source: Colgate 10K Filing

#2 - Convertible Bonds

Convertible bonds are debt instruments. By owning convertible bonds, the owners can convert them into common stock.

source: aviator.aero

#3 - Convertible preferred stocks:

As the name suggests, these are preferred stocks. These stocks pay dividends too. But if the owners of these convertible preferred stocks want, they can convert their preferred stocks into common stocks.

source: Yelp

Dilutive securities are more important because companies issue convertible securities to attract investors. The basic EPS is always more than the diluted earnings per share. If the basic EPS is less than the diluted EPS, then that particular diluted securities would be removed from the calculation of diluted earnings per share (anti-dilutive securities)

This article has been a guide to what Dilutive Securities are. Here we discuss the types of dilutive securities, including convertible bonds, convertible preferred stocks, Options, and Warrants, with examples. You may also have a look at the following recommended articles in accounting –

• Types of Investment Securities
• Security in Power BI
• Diluted Shares
• What is Exercise Price (Strike Price)?