Watered stock is an example of a stock or other asset that is promoted with a value that has been inflated by means that are outside the actual market performance. Watered stocks were once a common phenomenon in many trading environments around the world, but rarely appear today. Much of the disappearance of the watered stock as a capital investment is due to changes in the laws that corporations use to issue stocks.
The approach derives its name from a strategy used with livestock in the old American West during the 19th century. At the time, cows and other forms of livestock were weighed and sold by the pound. Essentially, the strategy employed forcing excess water into the animals, temporarily bloating the animal and raising the weight. The higher rate resulted in a larger sale price, which directly benefited the seller. At the same time, the buyer would find that the acquired heads of stock would lose a great deal of weight in a very short period of time. Since watered stock involves a completely artificial process that temporarily inflates the total worth of the stock, the name had become synonymous with the financial move by the beginning of the 20th century.
As in the days of the Old West, watered stock still places the risk squarely with the investor. Watered stock works along the lines of inflating the claims about the value and current profitability of the company, in order to sell the stocks and bonds at a price that cannot be justified by the real value of the corporation. In the event that the corporation did not continue and creditors forced the company into foreclosure, the holder of the watered stock could be subject to lose not only the amount of the capital contribution, but also be liable for the face value of the issued shares of stock.
Capital investments such as a watered stock often look very good at the onset, especially since the stocks are presented as having a great deal more potential for return than they really possess. However, the degree of risk associated with watered stock is so strong that an investor would be well advised to avoid any deal where the stocks or bonds in question appear to be represented as being worth more than the current condition of the company can justify.
