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Current time:0:00Total duration:3:51

Video transcript

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 they're trading in the market, or I guess we could say the last transaction that's occurred in trading in the shares, they're trading at $2 a share. So the market is saying that each of those shares are worth $2. There's four of these 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 $2, the market is saying that this company's assets are worth exactly $8 right over here. The market value of the assets is the same thing as a 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 $2 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 $2 a share for simplicity. And by selling two shares that it just created for $2 a share, the company is able to raise another $4. So the whole reason why I'm going through this exercise is to ask a question. Did dilution take place? And there's different ways to think it. When you think about dilution, it's like you could imagine if you have a sweet syrup and if you add water to it, it becomes less sweet. Each kind of a 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 are the owner of this share over here before the share offering up here, you owned 25% of the company. After the share offering, you own 1/6. So after, you own 1/6 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, that maybe these shares are worth less. And that's the one thing I want to challenge. There is dilution in the percentage 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 $8, now you have six shares representing something that is $12. Because the company didn't just issue these shares and get nothing in return for it. It got $4 of cash. You can't debate the value of $4. $4 are worth $4. So now the assets of the company are worth $12. So you have $12 of assets, no liabilities, six shares, $12 divided by six shares is still $2 a share. So the value per share has not been diluted, just the percentage of the company that you happen to own.