Dilution

Dilution happens when a company creates new shares, so each existing share represents a smaller slice of the business. Your share count does not change, but your percentage of ownership, your share of the profits and your voting weight all shrink. Whether that hurts depends on what the company gets for the new shares.

Sources of dilution

• Secondary offerings, where a company sells new stock to raise cash (see Secondary offering).
• Employee stock compensation: options and restricted stock units vesting each year.
• Conversions of convertible bonds or preferred stock.
• Exercised warrants.
• Acquisitions paid for in stock.

Measuring it

Companies report both basic EPS and diluted EPS. Diluted EPS assumes in-the-money options, convertibles and other potential shares are turned into stock, giving a more conservative per-share figure. A widening gap between the two is a sign of growing potential dilution.

What to watch for

Steady dilution from stock-based pay is easy to miss because it happens a little each quarter. Comparing the change in Shares outstanding year over year shows the real pace; many large technology companies use buybacks partly to offset it. Frequent offerings by small, cash-burning companies can shrink existing holders' stakes sharply over a few years, which is why investors read a company's financing plans closely.

Related terms

• Shares outstanding
• Secondary offering
• Earnings Per Share (EPS)
• Share buyback
• Authorized shares