A:

Dilutive stock is any security that dilutes the ownership percentage of current shareholders - that is, any security that does not have some sort of embedded anti-dilution provision. The reason why dilutive stock has such negative connotations is quite simple: a company's shareholders are its owners, and anything that decreases an investor's level of ownership also decreases the value of the investor's holdings.

Ownership can be diluted in a number of different ways:

1. Secondary Offerings: For example, if a company had a total of 100 shares on the market and its management decided to issue another 100 stocks, then the owners of the first 100 stocks would face a 50% dilution factor. For a real life example of this scenario, consider the secondary offering made by Google Inc. in the fall of 2005. The company decided to issue more than 14 million shares of common stock to raise money for "general corporate purposes", and it diluted then-current holdings.

2. Convertible Debt/Convertible Equity: When a company issues convertible debt, it means that debtholders who choose to convert their securities into shares will dilute current shareholders' ownership when they convert. In many cases, convertible debt converts to common stock at some sort of preferential conversion ratio. For example, each $1,000 of convertible debt may convert to 100 shares of common stock, thus decreasing current stockholders' total ownership.

Convertible equity is often called convertible preferred stock. These kinds of shares usually convert to common stock on some kind of preferential ratio - for example, each convertible preferred stock may convert to 10 shares of common stock, thus also diluting ownership percentages of the common stockholders.

3. Warrants, Rights, Options and other claims on security: When exercised, these derivatives are exchanged for shares of common stock that are issued by the company to its holders. Information about dilutive stock, options, warrants, rights and convertible debt and equity can be found in a company's annual filings.

For more information on shareholder dilution and its costs, check out our Accounting And Valuing ESOs Feature and A New Approach To Equity Compensation.

RELATED FAQS
  1. What are the differences between dilutive securities and antidilutive securities?

    Learn how investors and accountants apply the terms "dilutive" and "antidilutive" to securities or the exercise of security ... Read Answer >>
  2. Why is a company's diluted EPS always lower than its simple EPS?

    Learn about diluted and basic earnings per share and why a company's diluted earnings per share is usually lower than its ... Read Answer >>
  3. Where does the stock come from when convertible bonds are converted to stock?

    First, let's define convertible bonds. A unique combination of debt and equity, they provide investors with the chance to ... Read Answer >>
  4. Why do companies release financial figures in terms of fully diluted shares outstanding?

    Learn why companies release their financial figures in terms of fully diluted shares outstanding so as to give a true picture ... Read Answer >>
Related Articles
  1. Investing

    The Dangers of Share Dilution

    Investors need to be aware of dilutive securities and how they can affect existing shareholders.
  2. Investing

    The Dangers Of Share Dilution

    Share dilution reduces the value of an individual investment and can drastically impact a portfolio.
  3. Investing

    Why Include Convertible Securities in Your Portfolio

    What are convertible securities and why you should include them in your portfolio.
  4. Investing

    Convertible Bonds: Pros And Cons For Companies And Investors

    Find out why businesses choose this type of financing and what effect this has on investors.
  5. Financial Advisor

    Worried About Stocks? Try on Convertibles

    Convertibles are a good hedge against equity market risk (if you're o.k. with losing a bit of upside potential).
  6. Investing

    Assess Shareholder Wealth With EPS

    Find out if management is doing its job of creating profit for investors.
  7. Investing

    Introduction to Convertible Preferred Shares

    These securities offer an answer for investors who want the profit potential of stocks but not the risk.
  8. Investing

    Investment Valuation Ratios

    Learn about per share data, price/book value ratio, price/cash flow ratio, price/earnings ratio, price/sales ratio, dividend yield and the enterprise multiple.
  9. Financial Advisor

    Is Now the Time for Convertible Bonds?

    Convertible bonds offer a competitive rate of return in what is a very tough market right now. Here's how they work.
RELATED TERMS
  1. Diluted Earnings Per Share - Diluted EPS

    Diluted Earnings Per Share (or Diluted EPS) is a performance ...
  2. Dilution

    A reduction in the ownership percentage of a share of stock caused ...
  3. Deferred Equity

    A type of security, such as preferred shares or convertible bonds, ...
  4. Anti-Dilution Provision

    A provision in an option or a convertible security. It protects ...
  5. Diluted Normalized Earnings Per Share

    A company's profit less one-time earnings, divided by both outstanding ...
  6. Convertibles

    Securities, usually bonds or preferred shares, that can be converted ...
Hot Definitions
  1. Notional Value

    The total value of a leveraged position's assets. This term is commonly used in the options, futures and currency markets ...
  2. Interest Expense

    The cost incurred by an entity for borrowed funds. Interest expense is a non-operating expense shown on the income statement. ...
  3. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
  4. Pro-Rata

    Used to describe a proportionate allocation. A method of assigning an amount to a fraction, according to its share of the ...
  5. Private Placement

    The sale of securities to a relatively small number of select investors as a way of raising capital.
  6. AAA

    The highest possible rating assigned to the bonds of an issuer by credit rating agencies. An issuer that is rated AAA has ...
Trading Center