What Is Additional Issue of Shares and How Does It Influence Investments?
When you invest long-term and medium-term, you can face such a stock market phenomenon as additional issue of shares. Not all investors understand how it influences the capitalization of companies or their share prices, so feel vulnerable in such situations. Today’s article is devoted to the details of additional issue of shares.
Under additional issue we understand issuing and selling new shares of a company in order to attract new capital. This measure is meant to neutralize negative factors that influence the economic situation of the company, to help expand the business, or to launch new projects that require investments.
A profitable company can allocate a part of the profit to reaching new goals. However, if the size of the profit is not enough or the new project requires a colossal influx of money, the company decides on an additional issue.
Another option is using loans and credits. These require extra expenses on serving them and paying off interests. This is not always profitable and increases the financial load on the company.
The influence of the additional issue on the share price is quite ambivalent. The share price may drop significantly and recovery will take quite long. However, the inflow of finance in the company generated at smaller expense will have a good influence on the company in the future.
- Attracting extra money to support or develop the business
- Increasing authorized capital
- Expanding the share of large investors for making them more influential in the company
- Avoiding extra expenses on paying off loans
- The board of directors and major investors decide to issue additional shares. They agree on the size of the issue and the initial share price.
- The decision is ratified based on the company charter.
- The authorities register the additional issue by all legal procedures.
- The issued shares are sold among the existing investors of the company. The remaining shares are placed in the stock market where they become available to anyone who wants them.
- The company charter gets amended, namely — the charter capital and the number of the shares in turnover.
In most cases, additional issue drives the share price down. In the future, the quotations can recover and even grow, but normally it takes quite long, several years sometimes.
The N production company had 1 million of shares in turnover that cost $1 each. Hence, the capitalization of the company reached $1 million. The board of directors and the stock meeting decided to attract additional investments sized $500 thousand. The money was necessary for building a new plant and expanding production to enter new markets.
Loaning money or issuing bonds is hardly profitable: as you remember, loans and interests must be paid off. So, they only could issue 500 thousands of new shares.
After clearing out all legal procedures and the issue itself, the shareholders in the first place were offered the issued shares. They bought 75% of the new shares, and the remaining 25% got to the stock market.
In the end, Company N got the necessary investment for development and the shareholders got extra shares to their portfolios. Over the first three years, the dividends were decreased but after the new plant was built and put into operation, dividend payments doubled.
The advantages are:
- The company gets extra investments for development.
- If the company is profitable, additional issue can make the quotations grow soon.
- Investors can expand their portfolios by buying extra shares.
- In the future, dividends might grow
The drawbacks would be
- The share of the company that each investor owns gets diluted (small investors are at risk).
- Dividend payments per share are decreased.
- Negative reaction of major investors to the additional issue leads to sales of large packs of the shares, which, in turn, can drop the shares.
If you are a large shareholder, you will have the right to buy new shares in the first place. Decide if you need it after carefully studying the financial reports of the company and the reasons for the additional issue. In certain cases, it would be better to sell the shares of the company and avoid losses.
If you are a small investor who holds just several shares of the company in their portfolio, you have the following options:
- You can sell the shares after seeing the press release or when the price starts falling and then try to buy them again at a lower price.
- You can analyze the financial situation in the company and buy the shares in your turn.
- You can do nothing and hold the shares as a long-term investment.
- You can sell the shares and find more profitable investment options if the company is issuing additional shares to avoid bankruptcy.
I do not look at the additional issue of shares as at a totally negative event. An investor should study the financial reports of the company carefully and find out why the company has decided on additional issue of shares.
If the financial situation is good, the additional issue may signal about a new stage in the development of the company and higher investment yield in the future.
Moreover, remember that each case is unique: what can be good for one company does not necessarily do good to another one.
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