Share dilution (also called stock dilution) happens when a company's number of shares goes up, so each existing share owns a smaller slice of the company and of its profit. It can come from new shares sold to raise money, from shares handed to employees, or from share options and convertible bonds that can turn into shares later. Diluted earnings per share (diluted EPS) is the profit divided by the share count as if those options and convertibles had already become shares. Basic EPS uses only the shares in issue today. Diluted EPS is the same or lower, and it is the more cautious figure to read.
Worked example
Company A earns $10,000,000 and has 10,000,000 shares, so basic EPS = $10,000,000 ÷ 10,000,000 = $1.00. It also has options that would add 600,000 shares and a convertible bond that would add 400,000, which is 1,000,000 extra shares in total. Diluted shares = 10,000,000 + 1,000,000 = 11,000,000, so diluted EPS = $10,000,000 ÷ 11,000,000 = about $0.91. For ownership, say you hold 1,000,000 shares, which is 1,000,000 ÷ 10,000,000 = 10%. If Company A sells 2,000,000 new shares, the total becomes 12,000,000 and your slice shrinks to 1,000,000 ÷ 12,000,000 = about 8.33%, even though you sold nothing. (This example ignores the small interest adjustment that accountants make for convertibles.)
Why it matters
Dilution matters because profit is shared among more shares, so a company can grow its total profit and still earn less per share. That is why it pays to look at diluted EPS and at the share count over several years, both of which are in the annual report (the income statement shows basic and diluted EPS, and the notes explain options and convertibles). Dilution is not always bad: if the money raised is used to earn more than the stake given away, the slice can be worth more than before. A rising share count is a question to look into, not a verdict. Ask what the new money or the shares paid to staff were used for, and compare with companies in the same industry.
Frequently asked questions
Basic EPS divides profit by the shares in issue today. Diluted EPS divides it by a larger count that includes the shares that options, convertible bonds and similar rights could create. Diluted EPS is equal to or lower than basic EPS.
Your ownership after dilution is your shares divided by the new total number of shares. If you hold 1,000,000 of 10,000,000 shares (10%) and the company issues 2,000,000 more, you hold 1,000,000 ÷ 12,000,000, about 8.33%.
No. If the money raised is used well, the smaller slice can end up worth more than the bigger slice was. Look at what the company did with the new shares, not only at the share count.
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