The Ultimate Guide to Stock Dilution
Dilution is the silent killer of returns for small-cap investors. This guide explains what it is, how companies do it, and how you can protect yourself.
What is Stock Dilution?
Stock dilution occurs when a company issues additional stock. The result is that the ownership percentage of existing shareholders is reduced, or "diluted." Think of a pizza: if you cut it into 4 slices, you have 25% of the pizza. If you cut it into 8 slices, you still have the same amount of pizza, but it's now a smaller percentage of the total relative to the number of slices.
"Dilution reduces your slice of the pie. If the pie doesn't grow fast enough to offset the extra slices, your share becomes worth less."
Common Types of Dilution
1. Public Offerings (PO)
A secondary offering is when a company creates new shares to sell to the public. This increases the total number of outstanding shares and raises cash for the company.
2. At-The-Market (ATM) Offerings
An ATM program allows a company to sell shares into the open market at prevailing prices over time. Unlike a traditional offering which happens all at once, an ATM acts like a slow drip of dilution.
3. Warrants & Convertible Notes
These are financial instruments that can be converted into stock later. They represent "potential dilution." A warrant gives the holder the right to buy stock at a fixed price. If the stock price rises above that price, the warrant holder will exercise their right, creating new shares.
How to Spot Dilution Risks
- Check the Cash Runway: Companies with low cash reserves are more likely to raise money soon.
- Monitor S-3 Filings: An S-3 filing registers new shares for potential future sale (Shelf Registration).
- Watch for Warrants: Look for "Warrant Liabilities" on the balance sheet.
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