Have you heard this one before? "Holy smokes! Illiquid Inc. is trading at $5 a share from a high of $50 a share, therefore it must be a good buy."

This is poor investing logic, especially when shares are heavily diluted. Why? Because if shares outstanding sharply increase (dilution) and share price remains constant, then market capitalization increases to an inconceivable level. To illustrate, let's take a look at 2006 Citigroup (NYSE: C) vs. 2011 Citigroup.

A tale of two Citis
Here is a calculation of market capitalization when share price peaked at $57 in December 2006.

Share price $57
Shares outstanding (billions) 4.9
Market cap (billions) $279
Here is a calculation of share price needed today (with 29 billion shares outstanding vs. predilution's 4.9 billion) for Citigroup to return to its 2006 market capitalization peak.
Market cap (billions)$273.6
Shares outstanding (billions)29
Dilution-adjusted share price$9.62

Postdilution, $9.62 a share is the actual five-year high, not $57 a share.

And here is the market cap if Citigroup's share price returned to its 2006 peak with today's outstanding shares.

Share Price$57
Shares outstanding (billions)29
Theoretical market cap (billions)$1,653

As you can see, if Citigroup returned to $57 a share, the company would be worth $1.6 trillion (four times the size of ExxonMobil, the world's largest company). The chances of that happening are about as good as the Royals winning the World Series this year. The bottom line: Citigroup might be a good buy, but temper your expectations.  

Keep an eye on other serial diluters. American International Group (NYSE: AIG) diluted shareholders during the bailout bonanza and there is chatter of another round of dilution to come. Through multiple stock offerings, DryShips (Nasdaq: DRYS) experienced a sizable increase in shares outstanding as well, making it highly unlikely share price will reach prerecession highs anytime soon.

Remember to watch for dilution and adjust share price expectations accordingly.    

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Fool contributor Adam J. Crawford does not own shares in any company mentioned in this article. The Fool owns shares of ExxonMobil. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.