Learn to use the Treasury Stock Method like a pro so you can use it on the job in Investment Banking, Private Equity, and Investment Management.
In this article, you’ll see:
The Treasury Stock Method (‘TSM‘ or ‘Treasury Stock Approach‘) captures the full impact of Options when we calculate a Company’s Share Count.
Companies report their current (or ‘Basic’) share count, which reflects all existing shares.
However, when we want to calculate a Company’s Equity Value or Enterprise Value, we need to use the ‘Fully Diluted Share Count.’
The Fully Diluted Share Count includes potential shares from Options, Restricted Stock, and Convertible Securities.
In particular, the TSM allows us to add the impact of Options into the Fully Diluted Share Count.
As we’ll see, we follow a slightly different process for adding in the impact of Restricted Stock and Convertible Securities.
Professionals across Investment Banking, Private Equity, and Investment Management use the Treasury Stock Method every day to value Companies.
In particular, the Treasury Stock Method is critical for completing core analyses like Discounted Cash Flow (‘DCF’) and Leveraged Buyout (‘LBO’) models.
This article will show you how to calculate the number of shares outstanding using the Treasury Stock Method.
The rest of the article will dive deep to give you the fullest possible picture. However, if youwant to hop straight to the3-Step Process for theTreasury Stock Method, click here.
Ramp up faster with all of our (free) deep-dive articles in our Analyst Starter Kit:
As mentioned above, Companies have two share counts:
To go from Basic Shares to Fully Diluted Shares Outstanding (or ‘FDSO’), we need to add the impact of three instruments:
Many companies offer their employees compensation in the form of Stock Options and Restricted Stock.
Employees typically earn the Options and Restricted Stock over a period of time called the ‘Vesting Period.’
When the Options or Restricted Stock ‘Vests,’ the employee is entitled to receive them.
Stock Options offer the employees the ‘Option’ to buy Shares of Stock at a specific price, called the ‘Strike Price’ (or ‘Exercise Price’).
In other words, to receive the underlying Shares, the employee must pay to ‘Exercise’ the Option.
In Finance, we use the Treasury Stock Method to add the new shares created when an employee exercises their Options.
Thus far, we have only mentioned Options and not Warrants.
There are differences between the two. But for the sake of the Treasury Stock Method, they are treated as one and the same.
If you’d like to dig deeper into Options vs Warrants, check out this article.
Unlike with Options, when Restricted Stock vests, the employee receives new shares. They do not need to pay to receive the Shares.
As we’ll see shortly, both Options and Restricted Stock can add new shares to the Share Count.
As a result, they must be incorporated when calculating a Company’s FDSO.
In addition to Options and Restricted Stock, two additional instruments can create new shares: Convertible Debt and Convertible Equity.
To keep it simple, we’ll refer to them as ‘Convertibles’
Companies often issue Debt and Equity instruments that can convert into new Shares of Stock in the future.
The buyers of these securities receive additional upside in the Equity of the Business. So, they typically require a lower Interest or Dividend rate in return.
The lower rate can be desirable to Companies with limited Cash Flow but with large growth potential.
Now that we’ve laid out the basics, let’s dive into Options to see how they increase the Share Count.
As we said above, Employees receive Options as they Vest. Once an Option vests, it becomes ‘Exercisable.’
However, just because an Option is Exercisable doesn’t mean that it has value.
For the Option to have any value, the current Price Per Share of the underlying Company’s Stock must be above the Option’s Strike Price.
If the Share Price is above the Strike Price, the Option is ‘In-the-Money’ (or ‘ITM’).
But, if the Share Price is below the Strike Price, the Option is ‘Out-of-the-Money’ (or ‘OTM’).
Because only ITM instruments have value, we exclude OTM instruments from Treasury Stock calculations.
With the Treasury Stock Method, we assume that employees Exercise all their ITM Options.
When employees exercise their Options, they pay the Strike Price and receive shares in return and the Company receives the Option Proceeds payment.
But now we have a problem.
The Options exercise increases the number of Shares, but the Company also received dollars.
How do we add dollars to the Share Count?
Read on to find out.
This is where the Treasury Stock Method calculations come into play.
The Treasury Stock Method assumes that the Company takes all the option proceeds and repurchases shares in the Stock Market.
The Repurchased Shares offset the new shares created by the Option Exercise.
Now the Company can convert the Options proceeds into an equivalent number of repurchased Shares.
The total impact is:
In the section below, we boil this entire Treasury Stock Method into 3 simple steps.
To calculate the impact of Options using the Treasury Stock Method, we can use the following steps:
3 Steps of the Treasury Stock Method in Detail
The total dollar value created (or ‘Option Proceeds’) is what the Company receives, but the dollars have to be converted into an equivalent number of shares.
The result will be the total number of Shares Repurchased by the Company.
This results in the Net New Shares that need to be added to the Share Count when calculating from Basic Share to Fully Diluted Shares.
We must mention here that the ‘Treasury Stock Method’ refers only to the Options mechanics above.
But in this article, we aim to show you the full picture of how to calculate the Fully Diluted Share Count.
To complete the picture, we need to add the impact of Restricted Stock and Convertibles.
As we said before, Restricted Stock Units (or ‘RSUs’) operate a little differently than Options.
As a result, the Restricted Stock Units dilution impact is a bit different.
Unlike with Option vesting, employees immediately receive their shares when RSUs vest.
Because of this, the Basic Share count already includes the impact of any vested RSUs.
So, we don’t need to add Vested RSUs to the Share Count.
As we’ll see later in the article, there are some instances where you include Unvested Shares.
There are also RSUs with performance conditions called Performance Stock Units (or ‘PSUs’).
We’ll dig into both of these items in a bit. For now, let’s move on to Convertibles.
There are two different ways to add the impact of Convertible Securities (again ‘Convertibles’) to the Share Count depending on whom you ask.
The two methods are:
To begin, let’s assume we have Convertible Debt with a Face Value of $1,000 with the Option to convert into 20 Shares of Stock.
In that case, the Conversion Price would be $50 Per Share ($1,000 / 20 Shares).
The simple approach practitioners would often employ in practice is to include shares from the Convertibles if the Price Per Share of the Company exceeds $50 Per Share.
However, there’s a more involved (but technically correct) two-step method.
We’ll keep this high-level here, but if you want to dig deeper into the If-Converted Method, check out this Article.
The If-Converted Method looks at the conversion impact of the Convertible versus the impact to Earnings Per Share for the Business post-conversion.
This is because a Company must pay Convertible Security holders either Dividends or Interest.
If the Company’s Earnings Per Share go down after the conversion (i.e., the deal is Dilutive), then the current shareholders are worse off.
In this First Scenario, we assume the Convertible holders would Convert. So, we add the new shares to the Share Count.
This happens when the Company is paying a large payment (Interest or Dividend) to current Convertible holders.
In other words, after removing the heavy Convertible Debt or Interest or Dividends payments following the conversion, the current shareholders benefit.
In this Second Scenario, we assume the Convertible holders would not Convert. So, we do not add the new shares to the Share Count.
In summary, the order for the Two-Step If-Converted Method is:
Let’s now look at a real-life example of the Treasury Stock Method!
Let’s use the Treasury Stock Method (or ‘TSM‘) to complete the Fully Diluted Shares calculation for Foot Locker as of their Q1 2021 filing (June 9, 2021).
To find the filings referenced below, you can visit sec.gov website or use a more advanced tool like bamsec.
Below are the items we’ll need:
First, we need to find Foot Locker’s Basic Share Count.
We can always find the Basic Share Count on the front page of the latest filing.
The latest filing will be either the 10K (Annual Report) or 10Q (Quarterly Filing) at different points in the year.
Below we can see the latest Basic Share Count is 104 million on the front page of the 10Q filing:
Next, we need to apply the Treasury Stock Method to find the impact of Foot Locker’s Options on the Share Count.
As we can see below, Foot Locker has Options data in its latest 10Q filing.
If the 10Q didn’t have any Options data, we would need to go back to the 10K filing to find the data.
The disconnect between the 10K and 10Q dates is viewed as OK because this is the best possible answer given the information available.
Note that in the filing, Foot Locker has three Options Counts:
Depending on the situation, we may use Exercisable or Outstanding options.
In the past, for a normal-course (i.e., non-M&A) analysis, we would use Exercisable Options.
In recent years, many practitioners use Outstanding Options in Non-M&A scenarios to be conservative.
This conservatism arises because Equity is a much larger component of compensation than in the past.
This is especially true in the Technology sector where Stock Options are often a large part of employee compensation.
Said differently, just a few years of additional Option vesting can make a BIG difference in the Share Count.
In an M&A scenario, we always use Outstanding shares based on the assumption that Foot Locker would need to pay its employees if the Company was sold.
Using the data from Foot Locker’s filings, we can now work through the 3 Step TSM Process to calculate the net new shares from Options.
First, we need to calculate the Option Proceeds from Option Exercises.
Below we can see the results of those calculations:
Second, we need to calculate the Shares the Company can Repurchase using the Option Proceeds.
Below we can see the results of those calculations:
Third, we need to calculate the Net New Shares by deducting the Repurchased Shares from the new Shares created by the employee Option Exercises.
Below we can see the results of those calculations:
In the end, depending on the approach, the Option exercises created between 0.4-0.8 million new shares that must be added to the Share Count.
Now that we’ve pinned down Options, let’s move on to Restricted Stock.
We also need to include the impact of Restricted Stock in the Share Count as well.
In the image below, we can see the Restricted Stock disclosure for Foot Locker.
Foot Locker has two types of Restricted Stock:
Basic RSUs have been common for some time. But in recent years, far more Companies issue PSUs.
Unlike what we saw with Options, there’s only one total for RSUs which is Nonvested (also called ‘Unvested’) Restricted Stock.
There is only one total because all vested shares (especially traditional Restricted Stock) become shares upon vesting and are already included in the Basic Share count.
Similar to what we just saw with Options, the approach to RSUs has changed over time.
In the past, for non-M&A scenarios, we would ignore Restricted Stock altogether since traditional Restricted Stock enters the Share Count right away.
Today, many practitioners include all Unvested Restricted Stock.
They include all Restricted Stock to ensure they capture the full potential impact to the Share Count for the same reasons discussed above with Options.
For M&A analyses, similar to what we saw with Options, we assume that all unvested Restricted Stock vests with an Acquisition.
A brief search of Foot Locker’s 10Q filings shows that the Company doesn’t have any Convertibles.
So we can ignore Convertibles here.
Depending on the approach you take, you’ll arrive at a different answer for the Share Count, as you can see below:
The difference in Share Count based on each approach can have a large impact on a Company’s value.
Below we use the different Share Counts above to calculate the Fully Diluted Market Cap (Stock Price x Shares Outstanding).
As you can see, the difference in Fully Diluted Market Cap (or ‘Equity Value’) for Foot Locker is over $100 million.
Hopefully, you have a much better understanding of the Treasury Stock Method and the underlying idea behind the entire process for calculating a Company’s Share Count.
You can follow our 3-Step Process for the Treasury Stock Method to calculate Fully Diluted Shares for any Company.
The Treasury Method is critical to master for on the job success.
Investment Banking, Private Equity, and Investment Management professionals use the Treasury Stock Method every day.
Let us know if you have any questions in the comments below. We’d love to hear from you!
The Treasury Stock Method is an approach that allows us to convert the Option Proceed dollars into an equivalent number of shares used to calculate Fully Diluted Shares for a Company.
When an employee exercises Options, the Option exercise adds new shares to the Basic Share Count. In return, the employer receives money, but there’s a disconnect because we cannot add dollars to the Share Count. The Treasury Stock Method allows us to convert the Option Proceeds dollars into an equivalent number of shares to bridge the gap.
Basic Shares reflect the current shares in existence. Diluted Shares reflect all potential shares from Options (using the Treasury Method), Restricted Stock, and Convertible Securities.
When shares are Diluted, the share count increases. The increased share count lowers the value available for each shareholder.
Diluted Shares Outstanding reflect the Basic Share Count plus any potential shares. The drivers of potential shares are typically Options, Restricted Stock, and Convertible Debt or Convertible Preferred Stock.
Master the Unlevered & Levered Beta Formulas so you can use them in interviews and on the job in Investment Banking, Private Equity, and Investment Management. In this article, you will learn: TL;DR Want To Learn More About Finance? Ramp up faster with all of our (free) deep-dive articles in our Analyst Starter Kit: What […]
Purchase Price Allocation (PPA) concepts often cause quite a headache. We can make it easy. After reading this article, you will be able to master this concept for use both in interviews and on the job in Investment Banking, Private Equity, Corporate M&A, and Investment Management. In this blog post, we’ll discuss: TL;DR Purchase Price […]
Learn how to answer ‘Walk Me Through a DCF’ like a Pro with our proven, 5-step framework
Master the concept of Deferred Revenue so you can use it on the job in Investment Banking, Private Equity, and Hedge Funds or Mutual Funds. In this article, we will cover: TL;DR Why Does Deferred Revenue Matter? Deferred Revenue (also called Unearned Revenue) is a critical concept to master if you are aiming for (or currently working in) Finance. […]
Master Accretion / Dilution so you can ace your Investment Banking, Private Equity, and Investment Management interviews. We’ll break everything down with a simple 3-Step Framework as well as tips on how to avoid common pitfalls. Let’s jump in! In this article, you will learn: TL; DR Want To Learn More About Finance? Ramp up […]
EBITDA is a commonly used profit metric that represents a ‘proxy for Cash Flow.’ However, analysts must be careful when analyzing EBITDA because it excludes the impact of Depreciation & Amortization, Interest, Taxes, Capital Expenditures, and the impact of Changes in Net Working Capital. In this article, you will learn the definition, common uses, and pitfalls […]
The Paper LBO, a full LBO analysis completed with pen and paper, is an increasingly common question in Investment Banking and Private Equity interviews. Understandably, the thought of doing mental math on the spot and walking through an entire LBO analysis is intimidating. But Paper LBOs do not need to be such a scary prospect. […]
Want to understand how Hedge Funds vs Mutual Funds operate with simple, visual, and Plain-English explanations? After reading this article, you’ll understand: How Hedge Funds and Mutual Funds work. The difference between Going Long vs Going Short. How Hedge Funds lower the Volatility of their portfolios by Going Short. The differences between Hedge Funds vs Mutual Funds: Legal Structures, Liquidity, Investors, Fee Structures, and Long-Only vs Long/Short strategies. The contrast between Fundamental Investing vs Quantitative Investing. TL;DR Mutual Funds and Hedge Funds are Pooled Investment Vehicles that Invest Money in return for Fees. […]
