Rights issues and dilution

Chapter 4 ended with the row that matters: a rights issue you ignore makes your stake smaller. This chapter is why, and what to do about it.

What a rights issue is

A company needs money. Rather than borrowing, it offers existing shareholders the right to buy new shares, usually at a discount to the market price, in proportion to what they already hold.

A 1:4 rights issue at ₹300, with the share trading at ₹400, means: for every 4 shares you own, you may buy 1 more at ₹300.

Existing holders get first refusal, which is the point — it is a way of raising money without handing ownership to outsiders.

The discount is not a gift

The ₹100 discount looks like free money. It is not, and the arithmetic shows why.

Suppose you hold 400 shares at ₹400 — worth ₹1,60,000. You take up your rights: 100 new shares at ₹300, costing ₹30,000.

After the issue you hold 500 shares, and you have paid ₹1,90,000 in total. The theoretical price settles around ₹380 — the blended average — so your 500 shares are worth ₹1,90,000.

Exactly what you put in. The discount was compensation for the dilution the new shares cause, not a bonus on top of it.

What happens if you do nothing

This is the part that costs money.

If you do not take up the rights, you still hold 400 shares — but the price has adjusted down to about ₹380, because new shares were issued below the market price. Your holding is worth ₹1,52,000 instead of ₹1,60,000.

You have lost ₹8,000 by not acting, and your fraction of the company has fallen from 400/N to 400/(N × 1.25).

In India, rights are usually tradable: if you do not want to subscribe, you can often sell the entitlement, which recovers some of that value. Doing nothing at all is the one choice that is straightforwardly worse than the alternatives.

Why the company is raising money matters more than the terms

The mechanics above are arithmetic. The judgement is different, and it is this: what is the money for?

Funding growth it can actually earn a return on — new capacity, an acquisition that works. Dilution now, bigger pie later. Can be excellent.

Repairing the balance sheet — repaying debt it cannot service. Sometimes necessary, and it means you are funding survival rather than growth.

Repeatedly plugging losses — a company that returns to shareholders every couple of years for more money is telling you something the income statement may not have yet.

A rights issue is a company asking its owners for more capital. The terms are arithmetic; the reason is the investment decision.

Dilution you never get offered

Rights issues are the visible form. Two quieter ones matter as much:

Employee stock options. Shares issued to staff on exercise. Usually modest annually, and it accumulates — a company diluting 2% a year has issued a fifth of itself over a decade.

Preferential allotments and convertibles. Shares issued to specific investors, or instruments that later become shares. These arrive without an offer to you at all.

None of this shows on a price chart. A share price that doubled while the share count also doubled represents no gain per rupee of your ownership — which is why chapter 2 measured returns per share, and why chapter 6 is about reading the shareholding pattern.

The point

New shares mean everyone else owns a smaller fraction. A rights issue compensates you with a discount if you take it up and costs you if you ignore it — and the more important question is always what the money is for.