Treasury Stock Method

The treasury stock method must be factored into the diluted shares earnings in order to meet the generally accepted accounting principles (GAAP). It simply means that when a company is figuring out diluted shares it has to also figure out the shares that can be created due to in the money options and need to be added into the equation.

The formula looks like this.

(number of In The Money Shares)– (number of shares that can be repurchased)

For example company XYZ owns 1000 in the money options at $10 and the stock is trading at $20. This allows them to repurchase 1000 shares of the company. The proceeds the company will receive is $10,000 ($10 x 1000).

This means that the company will be able to repurchase 500 shares ($10,000/20). That means the new shares added is (1000 added – 500 repurchased or) 500 new shares.

The reason this is important is because it may bring in a lot of new shares into the market and the more shares that are brought into the market the less valuable each share becomes. Similar to how if you have 1 share of a pie that has 5 slices you own 1/5 of the pie. But if someone comes and cuts the pie into 10 slices there are more slices left and you now only own 1/10 of that same pie.

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