What is Watered Stock?
Watered stock is stock that is issued at a price far higher than the value of the issuer's assets.
How Does Watered Stock Work?
In technical terms, watered stock exists when the following is true:
Stock price x Shares outstanding > Net assets (or in some cases, capital invested)
For example, if the founders of Company XYZ invested $10 million in the company and then decided to take the company public by selling 50 million shares priced at $3 (a $150 million market capitalization), analysts might say that Company XYZ is issuing watered stock.
Why Does Watered Stock Matter?
Essentially, watered stock is another way to say 'overvalued stock.' Some sources claim that the term originated in the livestock trade, where ranchers would force cattle to drink lots of water the day before auction so that they weighed more.