Company Issuing more shares

[RaMa09]

A bit of a newbie when it comes to the sharemarket, so any help would be appreciated.

When a company announces it is issuing more shares does this normally lead to a drop in share price? And what reasons would a company issue more shares? Is it a bad sign?

 

[spartn]

Hey

If a Company is issuing more shares it is 99% of the time not a good thing. The main reason a Company would do so is because they are bleeding their Bank Balance dry, and issuing more shares tends to be a hell of a lot easier then getting more Debt, especially now days.

If you are looking at buying shares in a Company do some research, and look mainly at the Companies Market Cap (Value) and divide it by the current share price and it will show you how many shares the companie has listed.

Other bad things that come about when it comes to being a shareholder in a Company that issues more shares is YES the share price does usually fall. But also if you are an existing shareholder your holding of the Company drops and there also tends to be a drop in the Dividend Per Share the company pays out because there are more shares to go around now.

Spartn

:viking:

 

[dhukka]

A bit of a newbie when it comes to the sharemarket, so any help would be appreciated.

When a company announces it is issuing more shares does this normally lead to a drop in share price? And what reasons would a company issue more shares? Is it a bad sign?

There is no one easy answer to these questions. Even if a company issues shares for a 'bad' reason, the share price may still rise, I'll give an example of that below. Generally companies issue more shares to raise capital (additional funds). What you need to pay attention to is the reason they are raising more funds. Is it to fund expansion plans? Maybe for an acquisition? If it's biotech, it might be raising capital to fund clinical trials. A company may also issue shares just to stay solvent. Generally speaking though, if a company raises more capital and all other things remain the same the share price should fall because there are now more shares sharing in the same pie.

Determining what effect the capital raising will have on the share price depends on many factors. For example, if capital is raised for an acquisition. In that case, if investors perceive the acquisition to be reasonably priced then the shares might rise. If the prevailing wisdom is that the acquisition is expensive, then the shares might fall.

Another reason could be that the company simply needs more capital just to stay solvent. You only have to take a look at a lot of US financial institutions to see this kind of capital raising. In this case, existing shareholders are getting diluted significantly and all things being equal the share price will go down. However, even this is not cut and dried. As we have seen over the past year, many US financial institutions have announced they are raising capital and the share price has shot up. Often that is because the shares had already been beaten down so badly (ie a worst case scenario has been priced in e.g. isolvency) that the shares rally on the relief that the company was actually able to raise capital and stay in business.

From a fundamental perspective, the trick is to understand the effect of the share issue on the value of the company (not the price). This can usually only be determined well after the issue takes place, as then you can see what kind of returns you are getting on the extra capital that you have outlaid.

A perfect case in point was ABS. In order to maintain a high rate of growth ABS kept raising capital by issuing more shares (as well as raising some debt). Investors got excited because this translated into into higher profits. (put aside that those profits were dubious in light of the current accounting irregularites and restatement of profits) What investors failed to take note of was that everytime ABS issued more shares and then deployed that capital for acquisitions, the return on that capital was declining rapidly. In 2001 ABS showed an above return on equity of 25% and return on capital of 19%, by 2006 return on capital was 5% whilst return on equity was closer to 4.5%. However investors focussed on the increase in profits and ignored the return on capital - which is much more important for understanding business performance.

So you can see with the ABS example that even though the capital raisings were made to the detriment of the business the share price shot up, however, eventually over the long term the share price caught up the deteriorating fundamentals of the business.