DIlution of a share is like the Federal Reserve printing more money without taking some out of circulation.
If a company is worth $10 million and it has issued 1 million shares then each share is worth $10. If the company creates another 1 million shares then the previously issued share are suddenly worth half as much, $5.00. $5.00 times 2 million shares = $10 million.
Buying back shares is like reverse dilution, every existing share is now worth more.
Dilution can happen in some different ways.
The issue of convertible preferred shares, which are not counted in undiluted shares until they are converted to common stock. It may be good to know if there are a lot of unconverted preferred shares sitting on someone's shelf.
Compensation of the executives can be in the form of stock options - the executives are given the option of taking some stock at a time of their choosing, and according to some rules which may be incentives for performance, etc. When the options are exercised the total number of shares is increased thus the share of all are diluted.
If the incentive is effective, then the share price the market will pay may have risen sufficiently to compensate for the dilution.
It is smart to know the diluted share price of a company's stock. It is not immediately apparent when looking at the current market price which is a measure of undiluted share price.
==Related Fool Discussion Boards
== Post your questions on Motley Fool's "board name" board. [to board]
Recent Mentions on Fool.com
- Do Annaly Capital Management Inc. and American Capital Agency Corp. Have an Incentive to Dilute Thei
- Could Galena Biopharma, Inc. Be Running Out of Money?
- Can This 1 Breast Cancer Drug Turn Pfizer Inc. Into a Growth Stock?
- 1 High-Yield Dividend Stock I Would Avoid at All Costs
- Domino's Isn't Lying About its Improved Pizza Quality
- 2 Things Kraft Foods Inc. Stock Investors Need to Know