Dear Friends, capital dilution is one of the most crucial parameter to analyze any company. And also shows the ability of management to run business. So it is essential for us to understand what is capital dilution.
“Dilution is a reduction in the ownership percentage of a share of stock caused by the issuance of new stock.” – Investopedia
As per above definition, we can say that if we holding 1% of ownership in any company then that will reduce by dilution of capital.
So that due to dilution, partners in business will raise and ownership in business will falls.
Business which needs frequent capital to invest in the business then management having only 2 alternatives to raise fund; one is bringing debt and dilute capital.
Dilution of capital can provide good advantage to business in a good time but that dilution becomes curse for the business in a worst situation.
As we have seen in above example that company generated additional Rs.5 cr of profit but due to dilution that profit share got reduced. So for getting additional profit share, business need to generate above average profit. Due to increase in number of partner per share profit (EPS) will falls, which is negative for the owners of the business. In listed company, we as minority shareholders are an owner of the company. And dilution (increase number of partners) are negative for us.
By studying Cash flow statement, we can come to know about issuance of new capital.
Also when we check notes on share capital then also we can come to know the number of shares issued by the company.
Also Earning Per Share (EPS) gets diluted by issuance of new capital.
Thus, we have to be very careful with the business and management who frequently dilute capital for any purpose.