What Is Dilution in the Stock Market?
- Companies issue new stock into the market to raise capital. Proceeds from an offering may be used by a company to pursue projects, pay down debt, or expand. Regardless of the purpose, the end result dilutes the shares held by current stockholders, although some propositions are more attractive than others.
- Newly issued shares do not directly dilute the value or price of stocks held by current shareholders. When new shares are issued, the dilution occurs in the percentage of shares owned by current stockholders because the pool of available shares becomes greater.
- A company's board of directors sometimes agrees to reward top executives or employees with newly created shares in stock options. The holders of these contracts can choose to exercise or sell these options in the open market at a certain time, which dilutes the amount of shares outstanding, according to investment website Motley Fool.
- Dilution in the stock market may also be represented in quarterly earnings or profits by companies choosing to report earnings on a diluted basis. This method considers all convertible shares--including company stock options that have not yet been exercised--in results and typically leads to lower profits per share.
- When two companies merge, a buyer may pay for the target with cash, stock or a combination of cash and stock. When stock is involved, shareholders of the target company receive rights to trade stock in the acquiring company. As a result, common shareholders in the acquiring company experience a dilution in the percentage of shares owned.
- As Jim Jubak at MSN Money points out, a company with excessive amounts of debt on its balance sheet in relation to assets may be forced to issue additional shares in the market on an ongoing basis in an attempt to stabilize the balance sheet.
