What is share dilution?

Share dilution refers to the decrease in the ownership percentage of existing shareholders in a company when new shares are issued. This can occur for various reasons, and it typically has a dilutive effect on the ownership and therefore the voting rights and earnings per share (EPS) of existing shareholders. Share dilution can be a result of the following situations:

• Share issues: When a company issues new shares to raise capital, it can lead to share dilution. Existing shareholders’ ownership percentages decrease because there are more shares in circulation.
• Share Options and Warrants: Companies often grant share options or warrants to employees, executives, or investors. When these options or warrants are exercised, new shares are issued at a predetermined price, increasing the total number of shares and diluting existing shareholders’ ownership. The phrase “fully diluted share capital” refers to not just the issued shares of a company but also to those that would be issued were all of its existing options and warrants to be exercised.
• Convertible Securities: Companies may issue convertible securities like convertible bonds or preferred shares that can be converted into ordinary shares at a later date. When these securities are converted, additional ordinary shares are issued, leading to dilution.
• Mergers and Acquisitions: In some merger and acquisition deals, the acquiring company may issue its shares as part of the purchase price. This can dilute the ownership of the shareholders of the acquiring company if the acquisition is substantial.

Share dilution can affect existing shareholders in several ways:

• Ownership Percentage: Existing shareholders’ ownership percentage in the company decreases as more shares are issued, reducing their influence over corporate decisions particularly by reducing their percentage of votes.
• Earnings per Share: As the number of shares increases, the company’s earnings are spread across a larger number of shares, reducing the earnings per share.
• Share Price: Share dilution can put downward pressure on a company’s share price, as it may indicate that the company is raising capital or making acquisitions at the expense of existing shareholders.

To assess the impact of share dilution on an investment, investors often look at metrics like fully diluted earnings per share, which takes into account the potential dilution from outstanding share options, warrants, and convertible securities. It’s essential for investors (and companies) to consider the potential effects of share dilution when evaluating the long-term prospects of a company’s shares.

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