What is 'Dilution'?
-'Dilution' is the issuance of additional shares to the 'outstanding share count'. While not such a bad sounding definition, the impact of dilution can ruin a shareholder's position in a stock. The additional shares effectively 'dilute' the value of all shares on the market. Think of it like a pizza. The pie represents the market valuation of the company, while the slices represent the individual shares of the company's stock. When the company sells new shares, the pie doesn't get bigger, the slices simply get smaller. The investor is left with smaller slices.. or.. cheaper shares. Or if you want to think back to our swimming pool vs. coffee cup model model, dilution is like making the cup/pool wider. The increased capacity causes the liquid level, or price, to drop.
The direct effect of selling new shares can often be far more damaging than the proportional increase in shares warrants. Selling shares on the open market drives down the price; supply is increased, while demand stays the same. Without care a company can send their stock into a dilutive spiral that is very damaging to shareholders.
The purpose of dilution is for the company to raise money, plain and simple. In the grand scheme, the purpose for a company to go public in the first place is to provide a means for raising capital. You must find companies that do so in a responsible manner, without hurting shareholders. Always keep this in mind when trading any stock, and you will fall victim to dilution far less often.
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