Dilution is also termed as stock dilution. Dilution may occur from the issuance of extra common stock by a financial institution. This addition or increment in the number of common stocks or shares may occur from a number of conditions. They are secondary market offering, the practicing of stock options by the employees, changeover of preference shares, warrants or convertible bonds into stocks. Dilution may change the fundamental positions of the share, for example, earnings per share, voting right, percentage of ownership and the value of individual stocks. A wider explanation delineates that dilution is any occurrence that diminishes the stock prices of an investor lower than the initial buying price of the stock.
Control dilution explains the decrease in the percentage of ownership or the drop of a regulating share of the stocks of an investment. A large number of venture capital agreements include one stipulated anti-dilution condition for the privilege of the genuine investors for the purpose of providing protection to their stock investments. One method for raising fresh equity free from the dilution of voting rights is to offer warrants to every present shareholder evenly.
They have the option to invest more funds in the organization; otherwise they will suffer from loss of percentage of ownership. In case the employee stock options have the tendency of diluting the proprietorship of a regulating group, the organization may utilize cash for buying back the shares that have been issued.
Percent dilution is measured at a particular point of time. It can vary as market value varies and is not represented as a measurement of the effect of dilution.
The steps are the following:
Assumption that every convertible security is convertible on the particular date
Summing up the number of fresh stocks that are going to be issued as a consequence
Summing up the proceeds that are going to be received on these conversions and issues (the diminution of debt is regarded as a proceed).
Division of the entire proceeds by the present market value of the share to ascertain the number of stocks the proceeds may repurchase
Subtraction of the number of repurchase from the new stocks issued originally
Division of the net increment in stocks by the initial number of outstanding shares
Earnings dilution It delineates the decrease in the amount received as earnings per share of an investment because of an addition in the overall number of shares. The computation process of earnings dilution is obtained from the similar procedure, which is used in control dilution.
It explains the decrease in the present value of a share because of growth in the number of shares. This commonly happens when the issue of the stocks is done in substitution of the buying of a business and accumulated earnings from that new business should be equal to the ROE or Return on Equity of the former business.
In case the new stocks have been issued for income that is equivalent minimum to the previously existing book value of each share, no value dilution takes place. Often the market value of stocks is more than the book value. The entire value is not paid to the investors until the proceeds are equivalent to the market value.
Preference Share Dilution
The conversion of preference stocks is commonly performed on the basis of dollar-for-dollar.
Warrants and Option Dilution
The conversion of warrants and options is done at pre-determined rates. If the share price goes up, the value goes up on dollar-for-dollar basis.
Last Updated on : 1st July 2013