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Penny Stock Basics

Diluted Shares: Overview & How They Affect Share Price

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Written by Timothy Sykes
Updated 4/17/2022 17 min read

If you trade penny stocks, you must know the dangers of diluted shares.

Stock dilution can be common with a lot of these small-cap junk companies.

I see far too many new traders falling for the hype these companies pump out. So they think that penny stocks are too risky to trade. And they can be if you don’t follow the correct rules and understand how these companies operate.

Educate yourself on this now. 

Let’s go over penny stock diluted shares and diluted earnings per share. Plus, we’ll look at why companies do it and how dilution can affect stock price. 

What Are Diluted Shares?

A company’s shares become diluted when it introduces new shares to the market. 

Dilution can happen through a stock offering. Or it can happen through the conversion of warrants, stock options, or convertible notes. Dilution increases the number of shares outstanding. 

Penny stocks are notorious for stock dilution. Let’s get into why a company would want to dilute its shares …

Understanding Diluted Shares 

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The main reason a company would dilute its shares is to raise money. 

That’s why you see it so often in penny stocks — because they tend to be sketchy companies operating on little to no budget.

They’re small, developmental companies. Some might not even have a product on the market. If there’s no product or sales, there’s no income. 

A lot of these companies are usually desperate for cash. They need money to pay bills, make debt payments, pay employees, or further develop their product or technology.  

So to generate income they can either take on debt or sell more shares. 

How Do Shares Get Diluted? 

A company can dilute shares if its board of directors approves. But there are steps the company has to take before it can create new shares. 

It has to file the appropriate paperwork with the U.S. Securities and Exchange Commission (SEC). Then it has to disclose the new stock offering to the existing shareholders. This is usually done through a press release. 

Once the directors approve the issuance of new shares, the company can sell more shares into the market or obtain toxic financing in exchange for shares.  

Companies can also increase shares outstanding in other ways…

Stock splits and stock dividends are also ways of creating new stock. Instead of selling the new shares to the market, the company parcels them out to existing shareholders. This doesn’t dilute stock ownership, but it still results in a diluted share price. 

These moves don’t generate any new capital for the company. They’re looking to attract new investors with a lower stock price. We saw this with the recent Tesla Inc. (NASDAQ: TSLA) and Apple Inc. (NASDAQ: AAPL) stock splits. 

Splits and dividends are considered positives because they give value to existing investors. 

Is Share Dilution Legal? 

Yes, share dilution is legal as long as the company files the correct disclosures. 

But that doesn’t mean it isn’t shady. Penny stocks run in a cycle of stock dilution and reverse splits.

A company will announce some promising news, get its share price up, then do an offering of more shares. Eventually, the price goes back down and traders forget about the stock. Then the company will do a reverse split, which reduces the stock float and increases the share price. 

Then they start the cycle all over again…

What Happens When Shares Get Diluted? 

Think of the company as a pie. Say you cut a pie into four pieces to split among four people. Each gets a quarter of the pie. But then four more uninvited guests show up and want some pie too… 

So you cut the four pieces in half so all eight people can have a piece. But everyone gets a smaller slice because the pie didn’t get any bigger.

It’s the same concept with diluted shares.

When the number of shares for the company increases, the value of each share goes down, and so do the earnings per share. This can cause a lot of investors to sell their positions. 

Example of Diluted Shares

So I’m talking a lot about penny stock dilution, but larger companies can dilute their shares, too. With penny stocks, prepared traders know to expect the worst, so offerings aren’t always surprising. 

But with larger companies, it doesn’t happen as often — and can it signal big trouble. 

The pandemic crash put a lot of companies in trouble, especially airlines and cruise lines. 

Carnival Corp. (NYSE: CCL), United Airlines Holdings Inc. (NASDAQ: UAL), and Royal Caribbean Group (NYSE: RCL) all had offerings this year as they struggled to make money. 

Penny stocks typically have a bigger reaction to dilution because they’re so volatile. The whole market in 2020 has been extremely volatile. Check out my “Volatility Survival Guide” for tips on how to survive it and prepare for future volatility. 

Let’s look at a penny stock chart after a company announces an offering… 

In May 2020, this stock had huge volume, as it ran up from under $1 to almost $12. On June 4, the company announced a stock offering of 60 million shares at a price of $2 per share.

gnus offering chart diluted shares
GNUS chart: 1-day, 1-minute candle — courtesy of StocksToTrade.com

You can see it got halted multiple times as it crashed from the $11s to the $4s. Imagine if you weren’t at your computer that day to exit your position…

Find out which stocks I’m watching each week — delivered right to your inbox. Subscribe for my no-cost weekly stock watchlist here. 

What Are Undiluted Shares?

When investors talk about undiluted shares, they’re talking about undiluted earnings per share. 

It’s a way of calculating earnings per share without accounting for possible future dilution from convertible notes, warrants, or restricted shares. 

With this calculation, you get the best-case scenario for earnings per share, and it can make a company look better than it is. Especially if it has anything outstanding that can be converted into common stock in the future.

Basic vs. Diluted Shares: What’s the Difference?

Calculating fully diluted shares gives you the worst-case scenario for a stock’s earnings per share.

Diluted earnings per share include any convertible notes, stock options, and warrants, and anything convertible into common stock. 

But basic shares are the outstanding shares held by all shareholders at the time of calculation. Not accounting for possible future dilution. Similar to the undiluted share calculation.

It can give you a completely different picture of how the company is doing, compared to calculating the fully diluted earnings per share price. 

Fundamentals don’t really matter to me, because most penny stocks don’t have any. I expect the worst out of every stock and every company. 

My trading strategy doesn’t include researching earnings per share. I don’t hold my shares long enough to care. 

Instead, I trade patterns based on catalysts, volume, chart patterns, and technical analysis. And it’s made me over $6 million in the market.*

(*Please note that these kinds of trading results are not typical. Most traders lose money. It takes years of dedication, hard work, and discipline to learn how to trade, and individual results will vary. Trading is inherently risky. Before making any trades, remember to do your due diligence and never risk more than you can afford to lose.)

I also have multiple millionaire students from the strategies I teach in my Trading Challenge*.      

To get started learning my strategies, get “The Complete Penny Stock Course” book. My student Jamil put all my lessons together into this one resource. 

3 Warning Signs of Share Dilution

warning signs of diluted shares
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Let’s cover some basic warning signs that might mean a company is about to issue more stock…


Most companies have debt, penny stock companies especially. That’s not always a bad thing… 

But when a company has more debt than income, that can create a problem. If there’s not enough money to go around for regular operating expenses, plus debt payments, then the company needs to generate cash. 

If they don’t have a way to increase sales or reduce other expenses, they often look at selling more shares. 

Company Growth

Penny stock companies often put out positive press releases about a new product they’re developing or a study that had positive results. Sounds exciting, right? The company’s growing and expanding…

Not so fast. These are developmental companies. The new product, research, or expansion usually amounts to nothing. We’re not talking about Apple or another blue-chip stock expanding… 

We’re talking about sketchy companies that put out positive press releases to raise their stock price. Then they sell more shares into the hype. 

Don’t get sucked into the hype. Never believe that the money from an offering will make the company worth more in the long run. 

Huge Price Increases

With penny stocks, as soon as there’s a huge increase in the stock price, dilution is always possible. A big jump in a stock price could be because someone’s pumping and promoting the stock. 

A company might promote its stock ahead of an offering, or they might have outstanding warrants or convertible notes to dump on retail investors. 

When you see a penny stock up 100% or more in the premarket, check the SEC filings for possible dilution. It’s part of your due diligence. 

I made a DVD with my millionaire student Micheal Goode called “How to Read SEC Filings.” It’s not the most exciting video you’ll ever watch, but it’s important information. This information can help you avoid big losses. Study up!

Diluted Earnings per Share (EPS)

diluted earnings per share EPS
© Millionaire Media, LLC

With large-cap stocks and conventional investing, earnings per share is a common way that investors calculate the value of a company’s shares. If a company can raise its earnings per share, it generally increases the value of the company and the share price. 

But the number of shares outstanding affects the calculation. There are only so many earnings (or so much pie) to go around. If the number of shares increases, the earnings per share (or size of your slice of the pie) goes down. 

Calculating diluted earnings per share takes into account all outstanding shares, plus any warrants, convertible notes, or stock options that can be converted into common stock in the future. 

How Does Share Dilution Affect Share Price? 

Share dilution almost always results in a drop in the share price. There are a few reasons for that…

  • Short sellers. If there’s bad news released, short sellers are there to ride the stock price down.  
  • Supply and demand. Dilution creates more supply. It takes a lot more volume (or demand) to move a higher-float stock’s price up. 
  • Change in value. Current investors sell out because the shares aren’t worth as much as they were before they were diluted. 

Combine all those factors and you get lower share prices. 

To make things worse, an offering is usually at a price lower than the market value of the stock. That means all the people who bought above the offering price just overpaid. 

Even if the offering is done at the market price, the price will still usually go down. 

supernova placement

How to Calculate Diluted Earnings per Share? 

The diluted earnings per share (EPS) calculation looks like this: 

Diluted EPS = Net Income – Preferred Stock Dividends / Average Outstanding Shares – Dilutive Shares

If a company has dilution, the diluted EPS calculation will equal less per share than a basic EPS calculation.

How Can You Use Diluted EPS to Analyze a Business?

Diluted earnings per share can give investors an idea of what the price per share should be if all possible outstanding shares hit the market. 

It’s like knowing the worst-case scenario of your investment. If a stock is trading to high, you can wait for a dip to enter. Anything that can give you an edge in the market can help your trading or investing. 

Is Dilution Bad for Stocks?

is dilution bad for stocks
© Millionaire Media, LLC

With penny stocks, dilution is definitely bad for the price of the stock. You’ll likely see a huge sell-off and a decline in prices. 

But with large-cap stocks, investors have a bit more trust in the company. They could look at secondary offerings as a good thing in the long run. The company can raise more money and restructure itself without taking on any more debt. 

But some investors will look at it as a loss of value. 

This is why I say trading isn’t an exact science. It all depends on investor sentiment and their perspective of what’s considered good or bad. 

The Diluted Shares Conclusion

Diluted shares can signal trouble in penny stock land. Be cautious if a company announces offerings, warrants, or convertible notes, or if insiders are selling. 

Dilution usually causes a steep drop in share prices. And short sellers can add to the selling pressure. 

Always expect the worst out of every penny stock company. They generally don’t care about shareholders. They care more about raising money to continue their pump schemes. 

But that’s OK with me and my students. Because we know how to take advantage of these kinds of shady company moves. They can actually be quite predictable once you learn the patterns. 

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Learn how we do it. Apply for my Trading Challenge to access all my educational resources and a killer chat room. But don’t apply if you’re lazy and want to get rich quick. That’s not what I teach. 

I give people education, tools, and resources to help them become self-sufficient traders

Have you been affected by diluted shares when in a trade? Tell me about it in the comments. I’d love to hear about it…

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Timothy Sykes

Tim Sykes is a penny stock trader and teacher who became a self-made millionaire by the age of 22 by trading $12,415 of bar mitzvah money. After becoming disenchanted with the hedge fund world, he established the Tim Sykes Trading Challenge to teach aspiring traders how to follow his trading strategies. He’s been featured in a variety of media outlets including CNN, Larry King, Steve Harvey, Forbes, Men’s Journal, and more. He’s also an active philanthropist and environmental activist, a co-founder of Karmagawa, and has donated millions of dollars to charity. Read More

* Results are not typical and will vary from person to person. Making money trading stocks takes time, dedication, and hard work. There are inherent risks involved with investing in the stock market, including the loss of your investment. Past performance in the market is not indicative of future results. Any investment is at your own risk. See Terms of Service here

The available research on day trading suggests that most active traders lose money. Fees and overtrading are major contributors to these losses.

A 2000 study called “Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors” evaluated 66,465 U.S. households that held stocks from 1991 to 1996. The households that traded most averaged an 11.4% annual return during a period where the overall market gained 17.9%. These lower returns were attributed to overconfidence.

A 2014 paper (revised 2019) titled “Learning Fast or Slow?” analyzed the complete transaction history of the Taiwan Stock Exchange between 1992 and 2006. It looked at the ongoing performance of day traders in this sample, and found that 97% of day traders can expect to lose money from trading, and more than 90% of all day trading volume can be traced to investors who predictably lose money. Additionally, it tied the behavior of gamblers and drivers who get more speeding tickets to overtrading, and cited studies showing that legalized gambling has an inverse effect on trading volume.

A 2019 research study (revised 2020) called “Day Trading for a Living?” observed 19,646 Brazilian futures contract traders who started day trading from 2013 to 2015, and recorded two years of their trading activity. The study authors found that 97% of traders with more than 300 days actively trading lost money, and only 1.1% earned more than the Brazilian minimum wage ($16 USD per day). They hypothesized that the greater returns shown in previous studies did not differentiate between frequent day traders and those who traded rarely, and that more frequent trading activity decreases the chance of profitability.

These studies show the wide variance of the available data on day trading profitability. One thing that seems clear from the research is that most day traders lose money .

Millionaire Media 66 W Flagler St. Ste. 900 Miami, FL 33130 United States (888) 878-3621 This is for information purposes only as Millionaire Media LLC nor Timothy Sykes is registered as a securities broker-dealer or an investment adviser. No information herein is intended as securities brokerage, investment, tax, accounting or legal advice, as an offer or solicitation of an offer to sell or buy, or as an endorsement, recommendation or sponsorship of any company, security or fund. Millionaire Media LLC and Timothy Sykes cannot and does not assess, verify or guarantee the adequacy, accuracy or completeness of any information, the suitability or profitability of any particular investment, or the potential value of any investment or informational source. The reader bears responsibility for his/her own investment research and decisions, should seek the advice of a qualified securities professional before making any investment, and investigate and fully understand any and all risks before investing. Millionaire Media LLC and Timothy Sykes in no way warrants the solvency, financial condition, or investment advisability of any of the securities mentioned in communications or websites. In addition, Millionaire Media LLC and Timothy Sykes accepts no liability whatsoever for any direct or consequential loss arising from any use of this information. This information is not intended to be used as the sole basis of any investment decision, nor should it be construed as advice designed to meet the investment needs of any particular investor. Past performance is not necessarily indicative of future returns.

Citations for Disclaimer

Barber, Brad M. and Odean, Terrance, Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors. Available at SSRN: “Day Trading for a Living?”

Barber, Brad M. and Lee, Yi-Tsung and Liu, Yu-Jane and Odean, Terrance and Zhang, Ke, Learning Fast or Slow? (May 28, 2019). Forthcoming: Review of Asset Pricing Studies, Available at SSRN: “https://ssrn.com/abstract=2535636”

Chague, Fernando and De-Losso, Rodrigo and Giovannetti, Bruno, Day Trading for a Living? (June 11, 2020). Available at SSRN: “https://ssrn.com/abstract=3423101”