Stock dilution occurs when company actions reduce the ownership percentage of current shareholders. Dilutive stock is any security that generates this reduction..The reason why dilutive stock has 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 ways:
1. Secondary Offerings: For example, if a company had a total of 100 shares on the market and its management issues another 100 shares, the owners of the first 100 shares would face a 50% dilution factor. In a real life example, consider the secondary offering made by Lamar Advertising in 2018. The company decided to issue more than 6 million shares of common stock, diluting then-current holdings of 84-million shares.
2. Convertible Debt/Convertible Equity: When a company issues convertible debt, it means that debt holders who choose to convert their securities into shares will dilute current shareholders' ownership. 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.