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Hi I'm a beginner in stock market investing and I often ask myself this question:

"how is it that I am protected from a company diluting me out as a shareholder?".

I have seen compagnies issue outstanding shares for financial reasons as well as issuing shares for employee compensation plans. For example I am eyeing a small weed company with low shares outstanding and I am worried about being diluted out by those two factors.

Is there any protection from the SEC or am I left on my own to fend for myself by reading share offering/dilution plans?

Thank you for your help

Kevin Yan
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    Related: Why is stock dilution legal? – Ben Miller Apr 05 '21 at 12:49
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    Why are you worried about dilution? – Flux Apr 05 '21 at 13:02
  • I dont know do share dilution cause your shares to be less valuable? – Kevin Yan Apr 05 '21 at 14:44
  • @KevinYan Not necessarily. See the question I linked to above. – Ben Miller Apr 05 '21 at 14:51
  • Oh I dont know but have you heard about share creation for employee comp plan as well as share offering for survival reasons? shares are not always created with investements – Kevin Yan Apr 05 '21 at 15:01
  • @KevinYan If you are asking about stock compensation as an employee, you should edit your question and put those details in. Your first sentence mentions investing, so it looks like you are talking about buying stock and are worried about dilution. – Ben Miller Apr 05 '21 at 15:05
  • Nope, compagnies can often issue shares to employee by printing them, as well as printing other shares in order to finance themselves. I am talking about investing in compagnies with low shares outstanding can often be risky due to the fact that management can print new shares. I am asking if there is a way I can protect myself from that or I have to read all of their share offering plans. – Kevin Yan Apr 05 '21 at 15:10
  • @KevinYan Thank you for the clarifications. Please edit the question to add the information from your comments into the question body. – Flux Apr 05 '21 at 15:29
  • Regarding the "small weed company". Is it a company listed on the NYSE or Nasdaq? Or is it a company traded on the OTC stock market (pink sheets)? – Flux Apr 05 '21 at 16:00
  • Imagine you were to buy 1 million shares of Microsoft, a company with about 7,430,000,000 shares outstanding in the publicly-traded "float" (setting you back a mere $246 million, by the way). Congratulations, you own a whopping 0.013458950%. How much more diluted could you be? – RiverNet Apr 05 '21 at 20:15
  • BTW, never confuse "shares outstanding" with "float". What you KNOW of are shares that are being traded in the markets now. What you probably DON'T know (unless you've read the company's disclosures in full) is how many restricted shares are held by insiders (employees, private placement investors, etc.) that haven't started trading yet and will most certainly dilute the shares currently trading. This is always a danger with small companies, because you could have MILLIONS of restricted shares just waiting to be free up and traded. – RiverNet Apr 05 '21 at 20:22
  • @SRiverNet If the number of restricted shares is public knowledge, shouldn't there be zero price impact when the restricted shares are freed and traded? – Flux Apr 06 '21 at 17:20
  • No, because the mere fact a share CAN be traded doesn't mean it will. BUT, when it comes to restricted shares being finally allowed to trade, it is often the case (especially with smaller issues like OTC-traded stocks) that there isn't enough buying demand to absorb what insiders are choosing to sell, and the price drops (albeit on a short-term basis sometimes). MANY variables that go into this, but I have seen cases where the restricted share total was larger than the public float, and the stock took a beating for awhile once they traded. (see https://moneyweek.com/glossary/stock-overhang) – RiverNet Apr 06 '21 at 17:26
  • @SRiverNet thats okay because in the long run if the compagy is a good company the stock price will adjust. what is really not that great is company diluting shares to finance themselves. Buffet always talks about investing in management with integrity and I think that is part of that. restricted shares are okay as we calculate the value of a company with either free cash flow or some other metric regardless – Kevin Yan Apr 06 '21 at 17:45
  • @SRiverNet what boggles my mind is that if the company shares new shares by issuing them the EPS will be lowered. I guess it is wise to calculate a company value based on multiple valuation models. Furthermore, if you are an investor and not a trader float does not matter to you as much. I dont know how long you hold for but over 20 years who cares about float lol – Kevin Yan Apr 06 '21 at 17:48
  • @Kevin, shares handed out as restricted stock all count when calculating EPS, regardless of whether they can be freely traded. It's only when a company issues NEW shares that EPS is affected, so you're right on that part. Issuance of new stock to finance ops is not unusual or necessarily bad. GameStop just announced, and their stock went UP because investors are supportive of the intended use of the money (op costs and so on). Diluting EPS isn't necessarily negative either. If a company earns the same net profit, all investors care is whether EPS is inline with industry expectations. – RiverNet Apr 06 '21 at 17:58
  • @SRiverNet how long have you been in the market for? with all the mismanagement I am reading and seeing all around I doubt that companies would be able to turn a profit with all those share issuance. GME even with all those share issuance in the long run will hurt all of these gamblers regardless. I don't know but for me this is a pretty iffy issue with all the sketchy accounting as well as corporate greed – Kevin Yan Apr 06 '21 at 19:01
  • New stock issuance is COMMONPLACE when it comes to mergers and acquisitions. Rather than taking on new debt through loans or bond issues, companies sell shares to pay some of the costs. And a company's profitability has nothing to do with how many shares trade. A company either makes money or it doesn't, whether they have one share outstanding or a billion. Share issuance is always a "poison pill" defense against hostile acquisitions too. So there are MANY valid reasons to do this that have nothing to do with greed or poor management. – RiverNet Apr 06 '21 at 19:33
  • Further, I would argue there isn't a company in the S &P 500 or DOW 30 that hasn't done additional share issuances more than once. When fundraising for a new company, it is NORMAL to issue new equity with each new funding round, which dilutes the ownership percentage of earlier investors but SHOULDN'T be dilutive of the valuation of their holdings overall. I used to work in investment banking helping new companies come to market, so I'm intimately familiar with this process. But again, new issuances are NORMAL for public companies, not a nefarious greed scheme by management. – RiverNet Apr 06 '21 at 19:36

5 Answers5

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The only way you can "protect yourself" is by voting against any share dilution plans at the annual general meeting. But everyone else there has votes as well, and there is every chance you will be out-voted.

It's a commercial decision whether or not to issue more shares, whether that's part of an employee incentive scheme, or simply to sell more shares on the open market. You can't prevent it if that's what the company decides to do. In most cases, the cost to you as a shareholder is zero or small.

Selling more shares brings new money into the company, meaning that you own a smaller proportion of a more valuable company. Even share option schemes for employees usually require the employees to pay something for their shares.

Simon B
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  • @KevinYan You could keep an eye out for share sales in the company's financial statements. Or, you could be like me, and not care about it. – Simon B Apr 05 '21 at 15:34
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    If a share dilution is bad, why would any shareholder ever vote for it? – Aganju Apr 05 '21 at 18:38
  • @Aganju because it isn't always bad. Often extra shares are sold to raise money to grow the company. Which is better, owning 1% of a $1M company, or 0.5% of a $2M company? – Simon B Apr 05 '21 at 19:30
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Your assumption from the comments is that shared are "created" when given out as compensation.

This is not true - companies must indicate how many shares are "held back" to be used as compensation for employees, directors, etc. That amount is typically accounted for by analysts, so their dilutive effect is already accounted for in the fair market value.

When a company actually issues more shares, then existing shareholders are diluted, but it does not mean that their value necessarily goes down. If a company worth $1 Million has issued 1 Million shares (each share is worth $1), and then issues another 1 Million, selling them for $1, then company now is worth $2 Million and has 2 Million shares, so the existing shareholders have not lost any value.

Obviously the price that they get for the second million shares highly depends on what the company intends to do with the investment - it is issues shares just to stay in business, that's an indication that the company is desparate and the new shares may be worth less (which does reduce the value of existing shares_). The opposite can be true, though. If it uses the proceeds to invest in something that will help them grow faster, then the value of existing shares can actually increase.

Ben Miller
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D Stanley
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  • This is kind of LOL post. A company cannot normally become more valuable by issuing shares. When a company issues new shares the stock price almost always decreases and this is considered a dilution of existing shareholder value. A typical case of share dilution happened in 2009 when many banks and insurance companies issued and sold new shares and in every case existing stockholders lost significant amounts of money. In the case of Citi bank, shareholders lost 10s of billions of dollars when Citigroup increased its outstanding shares from 5.5 billion to 22 billion. – Five Bagger Apr 05 '21 at 16:40
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Welcome new user, to literally answer your question

What prevents me from being diluted out as a shareholder?

You cannot "protect" yourself from it.

Dilution, and the various similar concepts you are referring to, are simply part of the nature of public stocks.

End of story.

If you don't like that concept, do not invest in stocks. Find alternate investments.

Fattie
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If you're going to invest, you do it at your own risk.

Nobody is going to protect you from your own investing decisions if you choose to do so without a) educating yourself or, b) using an investment advisor/broker to help you.

The short answer is, nothing protects you from dilution. You have no say in the matter (apart from deciding to sell your shares!).

That being said, dilution can take on many forms in its effects on a stock. Can it make your shares less valuable? By general definition, yes - anytime more of anything is available in the marketplace the less it's worth unless there's at least a reasonably equal rise in the demand for it.

Be careful about applying hard and fast rules in the stock markets though, because the moment you do that you'll find an exception (or lots of them!). Depending on the nature of the new issuance, it can have an equally beneficial effect over the longer term.

An example is when stocks split. Imagine if you'd owned Apple stock from it's initial IPO and never sold or bought any additional shares. Because of the number of splits over the years, you'd have a great many more shares than you started with, not to mention each one of those shares you own now is definitely worth more than its IPO price.

In such an instance, would you really care if your shares are "diluted" from what they were when you first bought them? I doubt it! (grin)

RiverNet
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You can't, unless it is an NYSE or NASDAQ stock. The current state of corporate law in the United States allows corporations to change their ownership by issuing new shares without compensating existing owners. Nearly all corporations traded on the major exchanges have provisions in their bylaws that allow the management of the company to issue new shares and dilute the value of existing shareholders to whatever level they desire. For example, an OTC company with a million shares selling at $20 each could issue 100 million new shares at $0.05 each and this would make the holdings of the existing shareholders virtually worthless and there is nothing they can do about it.

In the case of NASDAQ and NYSE there is a listing rule that any issuance of new common stock in excess of 20% of outstanding shares must be approved by a shareholder vote. So, this rule can prevent crazy dilutions but management can still rip you off of up to 20% of your money with no approval needed. Also, when a company gets distressed, often shareholders will paradoxically approve large dilutions, so you can get screwed anyway even with the 20% rule. Basically what is happening is that the management of the company enriches themselves at the expense of the shareholders. Welcome to the stock market. It's kind of reverse Ponzi scheme in which old shareholders are screwed to bring in new investors.

This is one of the reasons why stock market indexes are bullshit. They show the stock market just going up and up and up. But it is total BS. For example, in 2009 Citigroup quadrupled their shares from 5 billion to 22 billion and this caused their "value" and the index to go up, but the reality for actual investors is that they saw the stock price decline from 50 to 35. So, while the index was going up, the actual shareholders were losing money.

Five Bagger
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