What is the meaning of Dilution?

If a company issues new stock, the earnings per share and the book value per share decline. This happens because earnings per share and book value per share are calculated by dividing the total earnings or book value by number of existing shares. The larger the number of shares, the lower the value of each share. Lower earnings per share may trigger a selloff in the stock, lowering its price. That's one reason a company may choose to issue bonds rather than new stock to raise additional capital. If two companies merge, or a company buys one or more other companies, earnings may be diluted if they don't increase proportionately with the total combined number of shares in the newly created company. Further,' Dilution' can occur if outstanding warrants and stock options on an individual stock are exercised, and if convertible bonds and preferred stock the company has issued are converted to common stock. Companies must report the worst-case potential for such dilution, or loss of value, to their shareholders as diluted earnings per share.