Hey guys, it's sasha every investing article and youtube video out there seem to repeat the exactly the same thing share. Dilution is bad when a company issues more shares, it reduces the value of the shares that you hold, and that's a really bad thing here is something that you need to know. This is really important. They are wrong.

This is not true share. Dilution is great for your investment and in this video i am going to explain exactly why. That is the case and i'll show you why, in numbers towards the answer, make sure you stick around first off really quickly. What is share dilution share dilution is when a company issues new shares on top of the ones that already exist.

There are a number of different ways in which this happens and reasons why it happens, but here are the two most common ones. The first is, the company needs to go and raise capital. This, after all, is the whole reason why the company's gone public in the first place to make it easy to go and raise capital when needed, and the second is through employee compensation in the form of options and shares. So the argument that is presented every time is this: if a company has a hundred shares and the company is worth a thousand dollars, then each share is worth ten dollars.

If this company then issues 100 more shares, then the total number of shares is going to be 200 and now the total value of 1 000 is divided by 200 shares, and each share is now only worth five dollars. So your share has depreciated in value. The good news is that the mass here is wrong and i'm amazed how many people out there just repeat the same mantra: they'll beat the same thing without trying to actually understand it, and it's not very complex. If this company has a hundred shares that are worth ten dollars each and then goes and issues a hundred new shares and those 100 new shares generally have to be bought by somebody, the majority normal situations will be bought by people on the market who buy up These shares when they are issued, or in some cases on smaller volumes, employees exercising their stock options.

Now, when people go and buy those 100 extra shares for 10 in the market, the company's valuation becomes the sum of its old value, the 1 000 and the new cash. That's just turned up 1 000 more dollars. So now the company is worth two thousand dollars and each share is still worth ten dollars. This is something that people need to need to just take a step back and think about, in fact, that extra one thousand dollars in cash that the company has just collected is probably actually worth more than one thousand dollars because of what it can do for the Business, the extra cash in the bank improves the asset liability ratio.

It can reduce the cost of credit lines in the cost of borrowing it can allow the company to invest in more growth. It can fast-track reinvestment in the business it can increase. The company spend on research and development fast track. A lot of new innovation, build new facilities.

All of these things, potentially the company, maybe could not do before that money turned up so in a typical valuation of a business, you would probably increase your valuation by more than that extra amount of cash the company just collected. So, in actual fact, the share price may well go up rather than down in one of these scenarios. Now, when employees exercise their share options, the situation may be a little bit different, and i'm aware of that before anyone pointed out in the comments. If these options were granted a long time ago, the exercise price may be much lower than the current share price, and so the person exercising those options may be buying them at a massive discount.

That does happen, but in the overall grand scheme of things in a typical company, this will be a very small proportion of the overall share volume which will normally have no real impact on anything. In fact, it will usually have the opposite impact because of the implications of why these actions are being taken. You see early stage. Companies want to attract the best talent, the smartest people they want to attract the strongest leaders who can drive the business forward.

The problem with early stage companies is they, don't have the right sort of cash to pay those people they aren't making any revenue. They don't have the sort of money that would take to go and hire thousands of those kind of people. So what is it that they do? This is why those people that they are hiring those super smart, super talented people are being compensated with shares or share options. Instead, it gives the company the ability to pay somebody with money based on the company's valuation.

In five years time, instead of cash up front - and this is good - if you're an investor in the business - because it means two things - it means that the company is smart with managing their cash. They are not collecting huge funding rounds and then spending it all on paying ridiculous salaries and fancy offices and trust me. I have seen a lot of those kind of startups from having worked with lots of financial startups in the uk and abroad. You don't want to invest in those coming accounts, at least from my perspective, i, like investing in a company that understands how to run itself properly and understands how to keep cash tight early on, because that is a good thing.

The second thing that is good is because these super talented super smart people who have come into the business got those shares of share options. They now have skin in the game. If the company does well, those people also do well, and they do well disproportionately. If the company does particularly well so if they can go and put in that extra effort go and spend extra time or extra thinking on how to make things work, if they can push that needle even more, if they can sleep in the factory floor, if that's What it'll take they will go and do it.

They aren't just collecting a paycheck every month. Well, it doesn't really matter if they work hard or not. So the company goes and gets to hire those people who otherwise would be out of their price range, who otherwise they would not be able to hire, and they only and they not only get to do that. They also get to motivate them to work hard at the same time.

That is a huge bonus. There's a reason why the likes of parent here, tesla and other super fast growing companies going through huge growth phases, have taken this exact approach. Companies that issue new stock are focused on growth. They are raising capital for the projects within their business that need cash.

So when i see a company that is diluting its shares and growing like crazy at the same time, i see literally nothing wrong with that whatsoever. Mature companies that have limited growth potential and are stagnating will often be the ones buying back shares instead, so it is sort of like a good sign. In my perspective, when i'm analyzing a company anyway, sometimes people will say that these extra shares are bad because the earnings per share reduces and as a result, so does the valuation, because some people do all of their valuations based on a fixed multiple of past earnings. The problem here is not in the reduction in the earnings per share.

The problem is with using extremely basic ways of valuing a company that will never properly value a growth stock. Maybe those people should try a little bit harder, but here is the bit that you've been waiting for the numbers. That really matter, because i'm going to explain this in a really simple way, but i think some people might find kind of refreshing. Imagine you hold the stock of a company that is valued at make up a random number seven hundred dollars your target price for that company is much higher.

You think that the shares should be worth. I don't know eighteen hundred dollars and at this point the company goes and issues some new shares to raise capital. This is the point where a lot of investors will get angry. They'll say that their shares are being diluted and on the surface they are right.

Those new shares are being bought by people for just seven hundred dollars when you think that the real value of that share is actually fifteen hundred dollars, because that's your target price, so those people are buying the shares at a massive discount. That's a bad thing for the company right, but think about it like this from a slightly different angle, there are three different outcomes that can happen in this scenario, where new shares are being issued either the share price goes up, it stays level or it goes down. Now, if the share price stays level, absolutely nothing happens for some time after those new shares are issued. Then there is no impact on the share price.

It doesn't go up or down nothing's happened, so the issue of new shares has had no effect. If the company then instead goes and uses that extra cash that they have just generated, they've pulled in in the right way to reinvest in the business and as a result, the share price goes up because the company does well, then everybody is a winner you're, a Winner, because you're a shareholder and so are the new investors who have bought in at that point in time. So you would argue that the company have done really well. Could they have done just as well without issuing new shares? Well, you'll never know, but they took that choice and that choice paid off.

The last scenario is that the shares are issued and after some time the price of the shares actually goes down. So you're annoyed at this point, because the new shares diluted yours and that's what you're blaming things on. But here is what actually happened. The new investors went and put money into the company where you are a shareholder at a higher valuation than the value that it is right now.

So those new investors have essentially got a lower share of the company for the money that they've put in than they should have. The company managed to raise capital at a higher valuation than they should have. You, as a shareholder, should be very happy with this outcome. The fact that the company share prices under performing, and probably the company itself not doing as well as it should is a whole separate issue, as are the reasons for it that you need to go and look into.

You need to decide. You want to continue being invested in the company, but your investments have actually done well out of that injection of capital, which is a separate thing. I hope you found this useful. I hope it makes you think about share dilution in a different kind of way.

Don't forget to hit the like button featured by green so that more people can watch this video. Thank you so much for watching. I really really appreciate it. As always i'll see you guys later, you.