Stock Dilution Why the value per share does not really get diluted when more shares are issued in a secondary offering
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- Let's say we've got a company here that has
- exactly four shares, just to simplify things.
- Obviously very few companies have only four shares,
- but this will simplify the explanation.
- And let's say that each of those shares right now
- is trading in the market, or I guess we could say,
- in the last transaction that's occurred in trading these shares,
- they're trading at two dollars per share.
- So the market is saying that
- each of those shares is worth two dollars,
- there's four of those shares in total,
- and we're going to assume that this company has no liabilities,
- so the shareholders just outright own the assets,
- so if there's four of these shares times two dollars,
- the market is saying that
- this company's assets are worth exactly eight dollars.
- Eight dollars, right over here.
- The asset value, the market value of the assets is
- the same as the market cap in this case
- because we have no liabilities.
- Now what I want to think about is,
- what happens if the company wants to raise some more money?
- Let's say that they want to issue some more shares and sell them
- to raise some money to buy a factory or whatever.
- So what they literally do is,
- the board approves for them to literally create
- two more shares, so now they have a total of six shares outstanding,
- and then the company goes, they get an investment banker
- and they do a secondary offering in the public markets
- and they sell these incremental shares.
- And they're able to sell them, let's just say for simplicity,
- at two dollars per share.
- Normally when you increase the supply a little bit
- you won't get quite what the previous market value was,
- but you get roughly two dollars a share, for simplicity.
- And by selling two shares that they just created
- for two dollars a share,
- the company is able to raise another four dollars.
- So the whole reason why I'm going through this exercise
- is to ask a question.
- Did dilution take place?
- And there are different ways to think about it.
- When you think about dilution, it's like you could imagine.
- If you have a sweet syrup and you add water to it,
- it becomes less sweet.
- Each cube of that water, each drop of that water
- has less sugar in it. You've diluted it.
- And so there seems to be an analogy here.
- We now have more shares for the same company.
- And it is true.
- If you were the owner of this share over here,
- before the share offering up here,
- you owned 25% of the company.
- After the share offering, you owned one sixteenth.
- So — not one sixteenth, one sixth.
- So after, you own one sixth, or approximately 16%.
- So it looks like the percentage that you own of the company has been diluted
- and that's true to some degree.
- But sometimes the dilution takes on another meaning
- that somehow, because more shares are being used
- for the ownership of the same company,
- maybe these shares are worth less.
- And that's the one thing that I want to challenge.
- There is dilution in the percentage that you own,
- but there is not dilution in what the shares are worth.
- Because before, if you had four shares representing
- something that is worth eight dollars,
- now you have six shares representing
- something that is twelve dollars.
- Because the company didn't just issue these shares
- and get nothing in return for it.
- It got four dollars of cash.
- You can't debate the value of four dollars.
- Four dollars are worth four dollars.
- So now the assets of the company are worth twelve dollars.
- So you have twelve dollars of assets, no liabilities,
- six shares, twelve dollars divided by six shares
- is still two dollars per share.
- So the value per share has not been diluted,
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