Stock dilution

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Stock dilution발음듣기

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Let's say we've got a company here that has exactly four shares just to simplify things.발음듣기

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Obviously, very few companies have only four shares, but this will simplify the explanation.발음듣기

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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.발음듣기

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So the market is saying that each of those shares are worth $2.발음듣기

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There's four of these shares in total.발음듣기

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And we're going to assume that this company has no liabilities.발음듣기

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So the shareholders just outright own the assets.발음듣기

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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.발음듣기

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The market value of the assets is the same thing as a market cap in this case because we have no liabilities.발음듣기

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Now what I want to think about is what happens if the company wants to raise some more money?발음듣기

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Let's say that they want to issue some more shares and sell them to raise some money to buy a factory or whatever.발음듣기

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So what they literally do is the board approves for them to literally create two more shares.발음듣기

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So now they have a total of six shares outstanding.발음듣기

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And then the company goes, they get an investment banker, and they do a secondary offering in the public markets.발음듣기

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And they sell these incremental shares.발음듣기

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And they're able to sell them - let's just say for simplicity - at $2 per share.발음듣기

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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.발음듣기

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And by selling two shares that it just created for $2 a share, the company is able to raise another $4.발음듣기

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So the whole reason why I'm going through this exercise is to ask a question.발음듣기

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Did dilution take place?발음듣기

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And there's different ways to think it.발음듣기

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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.발음듣기

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Each kind of a cube of that water, each drop of that water has less sugar in it.발음듣기

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You've diluted it.발음듣기

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And so there seems to be an analogy here.발음듣기

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We now have more shares for the same company.발음듣기

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And it is true.발음듣기

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If you are the owner of this share over here before the share offering up here, you owned 25% of the company.발음듣기

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After the share offering, you own 1/6.발음듣기

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So after, you own 1/6 or approximately 16%.발음듣기

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So it looks like the percentage that you own of the company has been diluted.발음듣기

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And that's true to some degree.발음듣기

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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.발음듣기

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And that's the one thing I want to challenge.발음듣기

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There is dilution in the percentage you own, but there is not dilution in what the shares are worth.발음듣기

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Because before, if you had four shares representing something that is worth $8, now you have six shares representing something that is $12.발음듣기

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Because the company didn't just issue these shares and get nothing in return for it.발음듣기

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It got $4 of cash.발음듣기

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You can't debate the value of $4. $4 are worth $4.발음듣기

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So now the assets of the company are worth $12.발음듣기

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So you have $12 of assets, no liabilities, six shares, $12 divided by six shares is still $2 a share.발음듣기

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So the value per share has not been diluted, just the percentage of the company that you happen to own.발음듣기

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