Dilution is the disassociation of value from current common stock shares due to the issuance or conversion of additional shares of the same company into the market, causing value to be reallocated.
If a company issues a follow-on (aka Secondary) issue of shares, or if many holders of convertible shares decide to use their conversion privilege, the share price will be diluted. Each share’s value will decrease because there are now an increased number of shares dividing up the same amount of earnings that the company generates.
Diluted earnings per share (EPS) is a calculation that shows what the earnings per share would be in the event that all outstanding convertible securities issued by the company were converted at the same time. In most instances dilution is minor and does not cause much trouble.
In other cases the dilution can start an inflationary spiral if a company is issuing too many shares to raise capital while the business is struggling and shares are being sold off and losing value.
A death spiral could also result from unwisely structured convertible securities which expose the rest of the shareholders to an unknown amount of dilution risk.
If short selling and conversion puts too much downward pressure on the price it’s very hard to stop it.
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