Stock dilution | Stocks and bonds | Finance & Capital Markets | Khan Academy


Let’s say we’ve
got a company here that has exactly four shares
just to simplify things. Obviously, very few companies
have only four shares, but this will simplify
the explanation. And let’s say that
each of those shares right now they’re
trading in the market, or I guess we could say
the last transaction that’s occurred in trading
in the shares, they’re trading at $2 a share. So the market is saying
that each of those shares are worth $2. There’s four of these
shares in total. And we’re going to assume
that this company has no liabilities. So the shareholders just
outright own the assets. So if there’s four of
these shares times $2, the market is saying that
this company’s assets are worth exactly $8
right over here. The market value of the
assets is the same thing as a market cap in this case
because we have no liabilities. Now what I want
to think about is what happens if the company
wants to raise some more money? Let’s say that they want
to issue some more shares and sell them to raise
some money to buy a factory or whatever. So what they literally
do is the board approves for them to literally
create two more shares. So now they have a total
of six shares outstanding. And then the company goes,
they get an investment banker, and they do a secondary
offering in the public markets. And they sell these
incremental shares. And they’re able to
sell them– let’s just say for simplicity–
at $2 per share. Normally when you increase
the supply a little bit, you won’t get quite what the
previous market value was, but you get roughly $2
a share for simplicity. And by selling two shares that
it just created for $2 a share, the company is able
to raise another $4. So the whole reason why I’m
going through this exercise is to ask a question. Did dilution take place? And there’s different
ways to think it. When you think
about dilution, it’s like you could imagine
if you have a sweet syrup and if you add water to
it, it becomes less sweet. Each kind of a cube of that
water, each drop of that water has less sugar in it. You’ve diluted it. And so there seems to
be an analogy here. We now have more shares
for the same company. And it is true. If you are the
owner of this share over here before the
share offering up here, you owned 25% of the company. After the share
offering, you own 1/6. So after, you own 1/6
or approximately 16%. So it looks like the percentage
that you own of the company has been diluted. And that’s true to some degree. But sometimes the dilution
takes on another meaning, that somehow because
more shares are being used for the ownership
of the same company, that maybe these
shares are worth less. And that’s the one thing
I want to challenge. There is dilution in
the percentage you own, but there is not dilution in
what the shares are worth. Because before, if you had four
shares representing something that is worth $8, now
you have six shares representing
something that is $12. Because the company didn’t
just issue these shares and get nothing
in return for it. It got $4 of cash. You can’t debate the value
of $4. $4 are worth $4. So now the assets of the
company are worth $12. So you have $12 of assets,
no liabilities, six shares, $12 divided by six shares
is still $2 a share. So the value per
share has not been diluted, just the
percentage of the company that you happen to own.

27 thoughts on “Stock dilution | Stocks and bonds | Finance & Capital Markets | Khan Academy

  1. But the point is, the company can't get $2 for the new shares, because the company is only worth $8! If the company issues 1,000,000 new shares, no one's going to pony up $2,000,000 and say "Hey, I now own a company that's worth $2,000,008." Or maybe that is what they're saying — "I think this company can create new factories with my money that will be worth $2 for every $2 I give them?

  2. nice scam…so if i know my company is going to get a big contract I can dilute the stock, buy a larger share, then take a bigger chunk of the profits I am going to make on the contract.

  3. Very dilutive and a sick practice that was all to common during the dot com days but the public kept buying the stocks anyway.

  4. Thanks for replying, but I feel that this answer confuses me even more. I tried searching for the term "coming out on the float" but google doesn't return any hits relating to finance.

    It would be appreciated if you could source or cite your information so that I could refer to it as well. Thank you for trying.

  5. If i wanted to kick out a shareholder in my company who is refusing to leave, and i am the majority share holder in that company (UK company), can i dilute the shares to a point where it becomes worthless ? (ie creating more shares without bringing in an investment)

  6. How does a corporation know the limit of the number of shares that is demanded by the market? If it issues too many shares then won't it hurt its own stock price or even turn into a South Sea Bubble or a Mississippi Scheme?

Leave a Reply

Your email address will not be published. Required fields are marked *