What is a share dilution ?
As we know, a company has a certain amount of outstanding shares. But sometimes, a company has to dilute their shares. We will see what can cause a share dilution and what are the effects of it.
What is a share dilution ?
Shares dilution happen when a company will issue new shares, augmenting the total number of outstanding shares and then reducing the investor’s ownership’s value. This is called dilution.
What can cause a dilution?
Conversion by holders of stock options securities
A member of a company can convert his options into shares, and the augmenting the total number of shares.
Secondary offerings to raise capital
It will happen when a company needs more capital. For this case, a Private Placement is very common. A PP will add more shares and will lower the current Stock Price
Offering new shares in exchange for acquisitions or services
Instead of buying cash a firm, a company can grant new shares to the firm they want to acquire
Can I see a dilution incoming ?
As we saw, a lot of scenarios can occur to a dilution. It can simply happen because of a need of more cash, to reduce liabilities… A dilution is generally triggered by growth opportunities, which is a great indicator of potential dilution. A company expanding fast with low cash flow will be more likely to issue new shares through secondary offerings, acquisitions for expansions.
A second possibility is the share dilution through stock options. This is the one reason you have to be particularly mindful when companies great employees a large number of optionable securities. When employees exercise their stock options, it can have a big impact on the total number of shares.
Price per share after dilution
After a public announce of a private placement, acquisition… You might want to know what your Stock Price will worth.
The Stock Price will generally fall at the agreement price, creating then a new bottom, or a “guaranty” under that the stock price won’t go. But be wary, it doesn’t have a real bottom. The Stock Price can go under the agreement price anyways.
What to conclude about dilution ?
Even if a dilution isn’t well appreciated by short term investors, you have to think long term, think about the bigger picture. For you, it will grant you another opportunity to add more shares. For the company, it enables them to have a faster expansion, faster growth and more importantly, a bigger leverage.