A:

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.

For more information on shareholder dilution and its costs, check out Accounting And Valuing ESOs.

RELATED FAQS
  1. 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 >>
  2. Earnings Per Share (EPS) Versus Diluted EPS

    Is EPS worth more than Diluted EPS? Learn about EPS vs diluted EPS, how they are calculated, and the difference between the ... Read Answer >>
  3. Where Does Stock From Convertible Bonds Come From?

    Convertible bonds are considered a combination of debt and equity. Find out how a debt instrument converts into shares of ... Read Answer >>
  4. 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 >>
  5. The share price and company's secondary offering

    When a company increases the number of shares issued through a secondary offering, it generally has a negative effect on ... 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

    Convertible bonds: pros and cons for companies and investors

    Understand what effect convertible bonds have on investors and companies. Find out the advantages, disadvantages, and what the issue means from a corporate standpoint before buying in.
  3. 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.
  4. Investing

    Assess Shareholder Wealth With EPS

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

    3 Best High-Yielding Convertible Bond ETFs (CWB, ICVT)

    Discover how convertible bond ETFs can offer investors growth and income while hedging fixed income portfolios in a rising rate environment.
  6. Investing

    The Top 3 Convertible Bond ETFs for 2016 (CWB, ICVT)

    Obtain detailed information on the exchange-traded funds (ETFs) available for traders seeking ETF exposure to convertible bond investments.
  7. Investing

    Leverage Your Returns With A Convertible Hedge

    Find out how you can maintain your income stream by using this type of bond strategy.
  8. Investing

    Why This Convertible Bond ETF Is Surging

    This convertible bond ETF is delivering impressive returns, but it has some risks too.
RELATED TERMS
  1. Diluted Earnings Per Share - Diluted EPS

    Diluted EPS is a performance metric used to assess a company's ...
  2. Dilution Protection

    Dilution protection is a provision that seeks to protect shareholders ...
  3. Market Conversion Price

    The cost of converting a convertible security into a common stock, ...
  4. Convertibles

    Convertibles are securities, such as bonds, that can be turned ...
  5. Conversion Ratio

    The conversion ratio is the number of common shares received ...
  6. Convertible Preferred Stock

    Convertible preferred stock includes an option for the holder ...
Trading Center