What is financial dilution?

Financial dilution occurs when a company issues additional shares of stock, which leads to a decrease in the ownership percentage of existing shareholders. When new shares are introduced to the market, the total number of shares outstanding increases. As a result, each existing shareholder's claim on the company's earnings and assets is reduced because their proportion of ownership in the company diminishes.

For example, if a company has 1,000 shares outstanding and an investor owns 100 shares, they own 10% of the company. If the company decides to issue an additional 1,000 shares, the total shares outstanding will now be 2,000. The same investor's 100 shares now represent only 5% of the company. This dilution can be particularly impactful if the new shares are issued at an unfavorable price or if the market does not respond positively to the increase in share count.

Understanding financial dilution is essential for investors as it can affect their voting power and potential returns on investment. This concept highlights the importance of considering share issuance in investment decisions, as dilution can lead to lower value per share if not accompanied by an increase in company value.