Understanding stock dilution vs. stock splits is important as they have different impacts on the investor’s portfolio.
To clarify, American Airlines’ 2020 secondary emittance led to a 30% drop of the shares’ price as the market was diluted. Meanwhile, NVIDIA 2021’s 4-for-1 split made the stock more accessible on the market, increasing its value by 50%.
While diluted stocks lose the EPS and voting power, the splits usually maintain the proportion of ownership and attract new investors.
Impact on Ownership
The most apparent difference between stock splits and stock dilution is that while the former does not affect the ownership stakes of the investors, the latter results in lowered ownership. More specifically, if a company raises capital through the issuance of new share, it will reduce the proportion of ownership that each of its existing shareholders holds.
Such a drop in the ownership percentage has several implications, including the reduced control during decision-making and the potential decreased return from having a holding. For example, American Airlines issued 74 million shares in 2020 as part of its secondary offering, with each of its existing shareholders’ of 12%.
The issuer of stocks will typically not experience any such dilution when stock splits occur. That is, when a particular company’s shares are increased and their prices reduced on a pro-rata basis, the proportions of ownership for the investors will remain the same even though they hold more shares. For example, in August 2019, Apple conducted a 4-for-1 stock split, which increased the proportion of its shares from 3.4 billion to 13.6 billion. Therefore, while each of its shareholders experienced an increase in the proportion of ownership by a factor of four, the dilution of their ownership stake did not take place.
The following data illustrate these differences in greater details:
-
Dilution: When Plug Power issued 28 million shares through the 2021 offering, the share lost over 7% of its value due to price dilution.
-
Stock split stability: Around a year after Tesla’s 5-for-1 offering in 2020, the share price more than doubled, as the stock became more affordable for the investors.
Share Price Changes
Given that stock dilution usually results in a decrease, the first way to affect the stock price is to announce scenarios of dilution. In 2015, when Fitbit declared the secondary offering of 3 million shares, its price decline was 17% due to the fears of shares deluge in the market. The effect is evident, as more supply usually leads to the devaluation of the product.
With dilution, the company issues more stock and thus increases the number of released securities, which automatically affects the market value of either new or existing stocks.
The situation with stock splits is different. The event itself makes the stock cheaper since the total capitalization remains unchanged, but the per-share price is reduced due to an increase in a number of shares available.
For example, in 2020, when Apple carried a 4-for-1 split, the price per share fell from $500 to $125, making the stock more accessible for smaller private investors. As a result, over the year, its value grew by 81% due to the larger number of investors buying it.
To summarize, following the examples above, one may conclude that the outcomes of split or dilution may be estimated based on the fluctuations of Key Source Ratio, being the exact prices.
Market Perception
Stock dilution generally carries a negative connotation and is met with skepticism by investors. It is because dilution is often the result of companies selling additional stock to raise cash when they cannot do so otherwise. Similarly, when AMC announced an 11.5 million-share secondary offering in 2021, the share price dropped 20.91% because the market sees their shareholders’ value become diluted, and the balance sheet overleveraged.
In this regard, the market’s perception is correct as dilution usually means immediate selling pressure and is a sign of companies’ financial distress or aggressive expansion.
Stock splits, in turn, are usually seen as a favorable move because they make expensive stocks more accessible to the average investor. In fact, when Apple announced its 4-for-1 split in 2020, the price rallied 30.12% prior to the split date as investors anticipated the lower cost of shares. The same could be observed with Tesla and its 5-for-1 split in the same year as the price soared 68.93% in the two days leading up to the split date.
Market perception key metrics:
-
Dilution Reaction: Snap Inc.’s share price dropped 15.25% in the two months following the 2019 secondary offering to fund growth.
-
Split Anticipation: The 2021 NVIDIA shares rose by 50.61% before the split date because investors anticipated higher demand and liquidity after the event.
Voting Rights
Stock dilution may be detrimental to the voting power of current shareholders when new shares are added. Overall, the influence of stockholders is diminished in relation to companies’ decisions. An example of such dilution is the 2019 WeWork case, where issuing new shares during several financing rounds limited new and current investors’ influence on company governance.
Co-founder Adam Neumann was able to maintain substantial control of the company. He attained this level of control due to his multi-class stock structure, which allowed him to own units with significantly higher voting rutgers.
On the contrary, voting rights are not generally influenced by stock splits. For example, after the Alphabet’s 20-for-1 stock split in 2022, the balance of voting power remained the same. No stockholder had her voting power reduced since each share was split equally. Therefore, each investor retained the exact number of votes she held before the split.
Metrics testing voting impact:
-
Dilution impact: In Snap Inc.’s IPO in 2017, the company released its third class of shares, which stripped the new stockholder of their voting power.
-
Split stability: In this regard, it is to look at Apple, which executed a 4-for-1 stock split in 2020. Apple’s shareholders maintained their voting weights due to the retention of the voting balance.
EPS Adjustments
Stock dilution impacts earnings per share through a modification of the allocation. When AMC issued over 160 million new shares in 2020, its EPS dropped from -$2.22 to -$3.15 per share. The considerable dilution resulted in a negative adjustment, which worsened the financial situation of the company because the investors now had a smaller fraction of the overall earnings. On the other hand, stock splits do not affect the EPS value but adjust the number in accordance with the split ratio.
In case of Tesla’s 5-for-1 split, the number of shares was modified by the split ratio, and the EPS was adjusted accordingly.
In this case, the split EPS was $0.15, compared to $0.76 quarterly EPS per share before the split. As such, even though the EPS was adjusted, the total earnings and shareholder value remained the same, and each share is still a portion of the earnings that existed before, adjusted proportionally.
Key metrics related to the EPS adjustments:
-
Snap: After Snap Inc. issued a secondary offering in 2019, the company’s annual EPS dropped by almost 28%.
-
Apple: When Apple performed its 4-for-1 split in 2020, its adjusted quarterly EPS after the split was $0.73.
Regulatory Implications
The infamous “ WeWork IPO” fall apart in 2019 in part because of stock dilution: its multiclass share structure was deemed to set up the company’s shares too easily for dilution in a friendly takeover. Besides strong opposition from the SEC and investors about perceived excessive dilution and governance issues, the offering ended in an extraordinary loss of confidence and postponed indefinitely.
The determination is straightforward, new shares issued in either a secondary offering or through the conversion of instruments must be done carefully and follow strict disclosure requirements to limit the possibility of severe regulatory scrutiny.
In comparison, stock splits are somewhat free from regulatory frictions because they do not affect the overall value of a company. To facilitate the 20-for-1 stock split by Amazon in 2022, instead of an SEC filing, it only needed to file an “AMENDMENT TO CERTIFICATE OF INCORPORATION” to to effectuate the increase in the total number of shares class stored by the company.
Key data illustrating the impact of regulation
-
Dilution Review: SEC reviews for dilution impact may influence offer pricing. The issuance of non-voting shares to finance Snap Inc. in 2017 to mitigate dilution risk ran into a governance risk and missed expectations for the amount that investors might be willing to pay in the short run
-
Split filing: Apple’s 4-for-1 split in 2020 also only needed an SEC filing but no further regulatory scrutiny for its effect on Apple’s capitalization was positioned at $0.00001.
