Dilution

When a company creates new shares, each existing share represents a smaller slice of the business. Shareholders who do not buy any of the new shares end up owning a smaller percentage than before.

For example, an investor owns 100,000 shares of a company with 1 million shares outstanding, giving them 10% ownership. If the company issues 250,000 new shares to other investors, there are now 1.25 million shares, and the investor's stake falls to 8%.

New shares can be issued for many reasons: to raise money, pay for acquisitions, reward employees through share-based compensation or convert bonds and preferred shares into ordinary shares.

Dilution does not always reduce the value of an investment. If the company uses the money raised to invest in projects that earn good returns, the business may become more valuable, offsetting the smaller ownership share.

Dilution also affects per-share figures. If profit stays the same but the share count rises, earnings per share falls. That is why companies report diluted earnings per share, which shows the effect of all potential new shares from options and convertible securities.