Definition of Dilution
What is the definition of the term "dilution" as it applies to the stock market? What does the term "dilution" mean?
In order to define this term as it applies to the stock market, let's first look up "dilution" in the dictionary.
"Dilution" is defined as:
"The process of making weaker or less concentrated"
If you are a shareholder of a company, dilution occurs when additional shares are issued or when convertible securities are converted into shares.
Let's say that there are 10 million shares outstanding in a company. The company issues an additional 1 million shares in order to raise capital, so that there are now 11 million shares outstanding in the company.
If you are a shareholder in this company, then the value of your total holdings have been diluted. If the shares are currently trading for $10/share, then the value of the company will not increase $10 million by issuing new shares. Instead, the company will likely be worth roughly what it was worth before the issuance of the new shares, meaning that each share of the company is now worth around $9.10/share.
In addition, earnings per share will also be diluted. Issuing new shares doesn't magically increase the earnings of a company, so earnings per share will fall in accordance with the issuing of the new shares.
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