Definition
The term dilutive securities refers to financial instruments that are not in the form of common stock but can be converted to common stock. Examples of dilutive securities include convertible bonds and preferred stock, warrants and stock options.
Explanation
Companies will issue dilutive securities for a number of reasons. Convertible bonds and preferred stock may include this feature to attract investors, since the ability to convert these issues to common stock lowers the risk of holding the security. Stock warrants may be issued to raise capital.
This type of security becomes dilutive when the holder exercises their right to convert it into shares of common stock. Once converted, the total number of shares outstanding increases, and the ownership of all shareholders is reduced.
The word diluted typically refers to the effect these securities can have on earnings per share. Since the earnings of the corporation are now divided among a larger number of shares, the earnings per share are said to be diluted.
There are circumstances whereby the conversion of dilutive shares has an antidilutive effect on earnings per share. For example, if a high yield bond were converted into common stock, the company's interest expense decreases, which increases earnings. This can happen when a bond issue carries a high coupon rate.
When this occurs, the security can be excluded when calculating the company's fully diluted earnings per share, which measures what happens if all of the convertible securities issued by a company are converted to common stock.
Related Terms
The term convertible preferred stock is used to describe one of several classes of preferred stock that can be issued by a company. To add to the marketability of this investment, convertible preferred stock provides the holder with the right to exchange this investment for shares of common stock.
Moneyzine EditorNovember 6th, 2024
The term convertible bond refers to an indenture issued by a company that is exchangeable for shares of common stock or the equivalent amount of cash. Convertible bonds are considered a hybrid security, since they contain both debt and equity features.Moneyzine EditorNovember 6th, 2024
The term capital stock is used to describe the authorized and issued transferable units of ownership in a corporation. Capital stock can include both common as well as preferred securities. The value of all capital stock issued can be found on the company's balance sheet.Moneyzine EditorNovember 6th, 2024
The financial ratio earnings per share, or EPS, is perhaps the single most popular variable used by analysts and investors to evaluate the profitability of a company. EPS measures the profitability of a company on a per share basis.Moneyzine EditorNovember 6th, 2024
The term antidilutive provision refers to agreements that protect investors from dilution in earnings or ownership that can occur when additional shares of common stock are issued. Convertible bonds and preferred stock, warrants and stock options can all lead to dilution of earnings as well as ownership in a corporation.Moneyzine EditorNovember 6th, 2024
The term antidilutive securities refers to financial instruments that are not in the form of common stock, but when converted into common stock will increase earnings per share.Moneyzine EditorNovember 6th, 2024
