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create your free account in 2015
canopy growth canadian marijuana company
end of the year with roughly 98 million
shares outstanding that means that if
you purchased a million shares you
respectively would have owned one
percent of the company's business
fast-forward to the end of 2018 however
and the company reported that their
share count had skyrocketed to three
hundred and forty three million shares
meaning that over the past four years
the company increased its share count by
two hundred and fifty percent and your 1
million shares that you had purchased
would now only represent twenty three
percent of the company this is a
phenomenon known as share dilutions and
it's something that negatively impacts
the value of the shares you hold in some
cases this share die lucien can allow
the company to meaningfully improve
their business many startups such as
those in the weed space argue that these
actions are necessary to grow rapidly
but sometimes dilution will destroy
shareholder value even if the company in
question ends up making more money how
let's find out on today's plain bagel
when a company first goes public the
ownership of the firm is divided into a
specified number of shares and
shareholders who purchased these shares
become partial owners of the business
for example if a company's ownership was
split amongst a thousand shares and you
purchased a hundred of them you would
effectively own 10% of the company but
after a company has IP owed that is when
they've gone public we may see more
shares issued by the company this
increases the number of shares
outstanding and effectively reduces how
much of the company each share
represents with our example if after you
purchase your 100 shares the company
issues another 500 shares then your
percentage ownership would be reduced
from 10 percent to six point seven
percent this is shared i Lucien
something that occurs when a company
issues shares in addition to what's
already outstanding and while the
average person may not care about their
shares losing voting power it can have
other negative effects on your position
why might a company issue extra shares
well there are a few reasons the first
of which may simply be to raise extra
capital you see a company may have a
project or expansion that they want to
pursue and if they don't have enough
money on hand to fund the opportunity
they may carry out what's known as a
secondary share issuance which is like
the initial public offering but it's all
secondary so they essentially make new
shares and sell them directly to new
investors or current investors to raise
money the company may also fund their
capital needs with what's known as a
convertible security a type of debt that
can be converted into shares these
securities don't initially cause any
dilution
but creditors may decide to convert
their debt into equity if it appears to
be an attractive move which would
naturally boost the number of shares
outstanding a company may also issue
shares to carry out a merger or an
acquisition similar to funding a project
a company may issue new shares directly
to an acquired business as a method of
payment thus increasing the number of
shares outstanding
finally we sometimes see shares diluted
as a result of employee compensation you
see a company will sometimes provide
employees stocks or stock options
instruments that can be turned into
stocks
at some point in the future as part of
their compensation this is particularly
popular with executives as it aligns
their interests with those of the
average shareholder but while this may
help reduce conflicts of interest it
also leads to well yes it shared I
Lucien so there are a number of reasons
why company may increase their share
count but are they worth it well the
answer to this really depends on the
specifics if a company is unable to
improve their operations with the money
they raise then the share dilation is
almost certain to hurt the value of your
stock and it's pretty easy to see why
more shares mean more investors laying
claim to a company's profits and if
these profits aren't growing to
compensate for the higher number of
shares then you are likely to see the
stock price fall for example imagine you
own one of 10 million shares of a
company that makes 50 million dollars a
year in this case your share of the
profits known as earnings per share is
$5 now if the company proceeds to issue
another 2.5 million shares in its
profits remain at 50 million dollars
then your earnings per share the
following year will go down to $4 in
addition when a company issues more
shares they generally have to do so at a
price that is lower than the current
market price of the stock this
inherently reduces the value of your
holding if your stock was worth $50 and
your company's selling the shares for 47
dollars it lowers the market price of
your position so sure dilution sounds
like a pretty big ripoff at this point a
company essentially raises money at the
investors expense in some cases however
sharda Ellucian may allow your company
to materially improve its business and
the pain caused by the share die lucien
may be offset by the improved
profitability of the firm going back to
our example imagine that the company
issues the additional 2.5 million shares
but the money they raise from the
issuance is used to buy a company with
intellectual property that is expected
to greatly improve the company's margins
and the next year they see their
earnings jump to 87 point 5 million in
this case your earnings per share will
increase from $5 to $7 a pretty solid
return so even though your percentage
claim over the company's earnings has
gone down
the size of the profit PI as a whole has
gone up to compensate for this and your
sliver ends up being worth more so if a
company can achieve a high enough return
on equity with the money they receive
from a share issuance the impact of
share dilution may be offset that being
said it's important to be skeptical of
companies issuing a lot of shares
because while raising capital may allow
a company to grow it doesn't guarantee
that management will be successful in
expanding the business worse yet the
process of issuing shares can and has
been abused in the past
well more money can allow a successful
company to improve their operations an
impaired business may issue shares just
to keep their head above water or worse
yet to take money from investors for
example imagine that the company you are
invested in is a start-up with negative
margins meaning that they are actually
losing money and the margins aren't
improving over time the company already
has a pile of debt on their hands and
they are running low on cash so to keep
the lights on they decide to issue more
shares they claim that these shares are
going to help the company turn around
but in reality the money simply goes
towards paying executives a little bit
more money in keeping the firm afloat
for just a little while longer clearly
in this situation the firm has
effectively taken money from
shareholders and likely won't provide
any material benefit as a result so what
a company does with the money they raise
from a share issuance is very important
here after all raising capital through a
share issuance is expensive for
companies current investors it's even
theoretically more expensive for a firm
than raising their debt levels so if a
company doesn't have a meaningful
strategy for improving operations with
the money raised then they are
essentially destroying shareholder value
for this reason it's important to
monitor a company's share count over
time and if a company is looking to
issue shares find out what the money is
going to be used for on the other hand
if you notice that a company's share
count is actually going down that is
usually a good sign for investors and in
fact many value investors look for that
because it means that a company is
buying back their shares a buyback is
when a company purchases their shares
from investors and effectively
cancels them they essentially increase
the worth of your position by reducing
the number of shares a company's profits
are split across you can view them as
being similar to when a company pays its
investors dividends because both involve
the company returning capital to its
investors it's important to see how a
company is finding its buyback
but generally speaking buybacks add
value to your shares so as mentioned
make sure to check out a company's
outstanding share count and look into
how the number has changed over time if
a company's buying back shares with free
cash flows great if they're issuing
shares make sure they have a strong
argument for raising the capital and be
skeptical of companies promising a
turnaround when they have an impaired
business finally when looking at a
company's first share metrics such as
EPS mixtures are taken to account the
company's diluted numbers as mentioned
earlier a company may have other
securities outstanding that can be
converted into shares at some point in
the future in diluted numbers show you
what the per share metric would be if
all these outstanding securities were
turned into stocks it's a great way to
conservatively analyze a company's
operations so share dilutions can
sometimes be a means to a positive end
but it's something that investors need
to scrutinize after all if the company
wants to raise money at your expense
they better have a good argument for it
and with that said we're out of time
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