When a company issues additional shares, this reduces an existing investor's proportional ownership in that company. This often leads to a common problem called dilution. The end result is that the value of existing shares may take a hit. This is a risk of investing in stocks that investors must be aware of. In this article, we'll look at how dilution happens and how you can protect your portfolio.
What Is Share Dilution?
Assume that a simple business has 10 shareholders and that each shareholder owns one share (10%) of the company. If each investor receives voting rights for company decisions based on share ownership, every shareholder has 10% control.
Suppose that the company then issues 10 new shares and that a single investor buys them all up. There are now 20 total shares outstanding, and the new investor owns 50% of the company. Meanwhile, each original investor now owns just 5% of the company (1 share out of 20 outstanding), because their ownership has been diluted by the new shares.
Source : Investopedia