Lately, a number of companies have sought to raise cash by issuing new shares. Unfortunately, if you already own a stock, that can pose a big threat to your investment.
Citigroup (NYSE: C ) recently announced that it wants to start repaying the government some of the $45 billion in TARP money it took. That seems like a good thing to do, and presumably many shareholders smiled at such news. But hold on -- there's a dark side. That's because the company will raise $20 billion in capital, and it'll come not by selling off some buildings, charging customers more fees, or laying off employees. It'll come from the company's issuing new stock.
Even that might not seem so bad to naive investors. But if you think everything's fine, you should learn a bit about dilution.
Here's a simplified example: Citigroup recently had about 23 billion shares outstanding, closing last week around $4 per share. If the company issues 5 billion new shares at $4, to collect $20 billion, it would end up with more money -- and more shares. So let's say that you were a big investor in the company, owning 2.3 billion shares, or 10% of the company. After the stock offering, you would own 2.3 billion shares out of 28 billion. Your stake in the company would no longer be 10% -- it would be closer to 8%. Thus, your share of its earnings would be slimmer. Indeed, the company's earnings per share (EPS) likely would fall, unless the dilutive effects were offset by booming earnings.
That's why savvy investors keep an eye on share counts, because quiet little actions like granting lots of stock or stock options to employees can boost the number of shares outstanding and thereby dilute the interests of existing shareholders.
Here are some other companies in the news because of dilution concerns:
- Both Bank of America (NYSE: BAC ) and Wells Fargo (NYSE: WFC ) plan to join Citigroup in raising capital by issuing more stock. My colleague Alex Dumortier has suggested that US Bancorp (NYSE: USB ) might be next in line to issue new shares, even though it already paid back its TARP money.
- Whole Foods Market (Nasdaq: WFMI ) has reported that some preferred stock it issued would likely be converted into common stock, adding at least 30 million or so shares to its 141 million shares and thereby boosting its share count by more than 20%.
- The share count of ATP Oil & Gas (Nasdaq: ATPG ) is up around 25% over the past year. The dilution hurts, but some think the company is better off with the extra cash, better able to handle its debt, and in a generally stronger competitive position.
Take dilution seriously, because it can drag down your portfolio's performance.
More and more companies are using their shares as currency for mergers. Read Toby Shute's analysis of ExxonMobil's latest acquisition.