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