Share Dilution

You can invest in a business by buying stocks (equity) or bonds (debt). You become part owner of the business when you buy stock, and you loan money to a corporate or government entity when you buy bonds. Profits are paid to shareholders in the form of dividends, and earnings are calculated on a per-share basis. Sometimes a company will issue a lot of shares, resulting in shareholder earning less. This is when share value becomes diluted.

Dilution is a reduction in earnings per share of common stock, occurring when additional shares are issued. Common shares increase during a secondary market offering, when employees exercise stock options and when convertible securities are converted. Dilution can cause significant effects like a shift in fundamental stock positions such as ownership percentage, voting control, earnings per share, or the value of individual shares.

You may find it helpful to learn how to calculate share dilution. Here's how to do it:

1. First, determine the number of shares outstanding. You can get this number from the balance sheet in the annual report. Look for number of shares outstanding under the stockholders' equity section of the balance sheet. For example, shares outstanding: $1 million.
2. Next, find the total number of possible shares outstanding in the balance sheet. Look for either total number of diluted shares/fully diluted shares or the notes under stockholders' equity. When investors change a security into common shares of stock, it increases the total number of shares outstanding. Total number of diluted shares: $2 million.
3. Find the net income in the annual report. Net income: $500,000.
4. Get basic earnings per share (EPS). Earnings per share is net income divided by the total number of shares outstanding. That is: $500,000 /2,000,000 shares = $0.25 basic earnings per share.
5. Get diluted EPS. Diluted EPS is net income divided by total possible number of shares outstanding (fully diluted shares outstanding). That is: $500,000 /2,500,000 shares = $0.20 diluted earnings per share. You'll notice that diluted EPS is less than basic EPS because the earnings are being shared with more shareholders.

Share Dilution Scams

In the imperfect world of unregulated markets, share dilution scams can sometimes happen. Companies issue massive amount of shares into the market for no reason, devaluing share prices and causing huge losses to shareholders. When share prices are at or near the minimum stock price, those fraudulent companies continue repeating the same scheme.