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Investment - Company Actions That Affect Equity Outstanding
Companies undertake big changes as they expand, evolve, mature, or merge with another company. Some of these adjustments result in changes to the number of common shares outstanding — that is, the number of common shares currently held by shareholders. The following table outlines several business acts that can alter equity outstanding. Each of the activities and their effects are detailed in the following sections.
Company Actions That Affect Equity Outstanding
Initial Public Offering (IPO)-Company sells shares to public investors for the first time (private company becomes a public company).
Seasoned Equity Offering (SEO) -Selling shares to the public after the IPO in a secondary (or seasoned) offering.
Share repurchase - Company buys back existing shares from shareholders.
Stock dividend or stock split - Company issues new shares to current shareholders without getting any money in exchange.
Spinoff = firm forms a new firm by spinning off some existing company assets.
Initial Public Offering
The major distinction between a private company and a publicly listed firm is that the shares of a private company are available only to chosen investors and are not exchanged on a public exchange. A private firm becomes a publicly listed company through an initial public offering (IPO), which is the first time that it offers new shares to investors in a public market.
Private corporations become publicly traded companies for a number of reasons. First, it provides the company more visibility, which makes it easier to raise cash to fund expansion prospects. It also helps attract talented people, build brand awareness, and gain credibility with trading partners. In addition, it provides better liquidity for stockholders who want to sell their shares or buy additional shares. At or after the IPO, some of the initial shareholders may choose to sell some of their shares. The fact that the shares now trade in a public market makes the shares more liquid and hence easier to sell.
A downside of becoming a public business is additional regulatory and transparency responsibilities.
Seasoned Equity Offering
After an IPO, publicly listed corporations may sell further shares to raise more funds for expansion. The selling of new shares by a publicly traded firm after an IPO is referred to as a seasoned or secondary equity offering. A typical seasoned equity offering raises the number of shares outstanding by 5%–20%. For a current investor who does not buy additional shares in the seasoned stock offering, the increase in shares outstanding dilutes their ownership percentage.
Another reason why a corporation may issue new shares is to fund a purchase of another company. For larger purchases, the acquiring business may pay for the transaction by issuing new shares. The amount of new shares issued depends on the purchase price and the ratio of the two companies’ stock values. An acquisition in which the firm utilizes its stock to finance the transaction results in an increase in the acquiring company’s shares outstanding. For current shareholders in the acquiring company, the extra shares outstanding effectively dilutes their ownership proportion.
Share Repurchases
Companies may choose to return funds to shareholders by repurchasing shares rather than paying dividends. The share repurchase will boost the company’s earnings per share since net income will be split by a reduced number of shares following the repurchase. Repurchased shares are either cancelled or maintained and reported as treasury stock in the shareholders’ equity account on the company’s balance sheet. Treasury shares are not included in the number of shares outstanding.
To buy back shares, a firm can buy shares on the open market just like other investors or it can issue a formal offer to buyback directly to shareholders. Shareholders may opt to sell their shares or to remain involved in the company. For an existing investor who does not sell shares, the drop in the number of shares outstanding effectively raises that person’s ownership percentage.
Stock Splits and Stock Dividends
Companies may, on occasion, execute stock splits or give stock dividends.
A stock split is when a corporation exchanges one existing common share with a specific number of common shares.
A stock dividend is a dividend in which a firm distributes more shares to its common shareholders.
Stock splits and stock dividends both increase the number of shares outstanding, but they do not modify any single shareholder’s proportion of ownership.
When a corporation splits its stock or issues a stock dividend, the number of shares outstanding grows, and more shares are issued equally to existing shareholders depending on their present ownership percentages. Because no new money is received for the new shares, the overall worth of the company should not change. So, the price of each share will decline. But the value of any single shareholder’s total shares should not alter.
Example: Effects of a Stock Split and a Stock Dividend
Consider an investor who owns 900 shares of a business with 24,000 shares outstanding and a current share price of EUR75.00.
Stock Split
Suppose the company announces a three-for-two stock split, which means for every two shares the investor now has, they would receive three shares in replacement. So, the investor with 900 shares will get 1,350 shares after the stock split.
(900/2) x 3 = 1,350 shares
Stock Dividend
Suppose instead the firm declares a 50% stock dividend – that is, for every share investors already own, they will receive an additional 0.5 shares. In other words, the investor with 900 shares will have 1,350 shares after the stock dividend.
900 × 1.5 = 1,350 shares
A stock split or stock dividend does not modify each shareholder’s proportional ownership of the company. Shareholders do not invest any additional money for the increased number of shares, and the stock split or stock dividend does not have any influence on the company’s activities. The overall value of the company’s shares and an investor’s shares are unchanged by the stock split or stock dividend.
Given that stock splits and stock dividends do not have any influence on company operations or value, why do you think companies take these actions? One rationale is that as a firm works well and its assets and income increase, the stock price is likely to climb. At some point, the stock price may reach so high that shares become unaffordable to some investors and liquidity reduces. A stock split or stock dividend will have the effect of lowering a company’s stock price, making the shares more affordable to a larger group of investors, so enhancing liquidity.
It is vital to remember that the affordability of a company’s shares is distinct from whether the stock is undervalued or overvalued. A corporation with a stock price of USD500 per share may be unaffordable to some investors but may still be considered undervalued when the price per share is compared with the projected value per share. Similarly, a company with a stock price of USD5 per share may be accessible to most investors yet still be overvalued.
Companies with very low stock values may undertake a reverse stock split to boost their stock price. In this situation, the corporation reduces the number of shares outstanding. The fundamental reason for a reverse stock split is because a firm may face the possibility of having its shares delisted from a public exchange if its stock price falls below a certain threshold stipulated by the exchange.
After the reverse stock split, stockholders will still possess the same proportion of the shares they initially had. In other words, a reverse stock split reduces the number of shares outstanding but, again, does not impact a shareholder’s proportional ownership of the company. After a reverse stock split, the stock price should increase by the same multiple as the reverse stock split. The following example describes a 1-for-8 reverse stock split by General Electric.
Spinoffs A company may create a new company from an existing subsidiary or package of existing assets in a procedure referred to as a spinoff.
Shares of the new entity are dispersed to the parent company’s existing shareholders. After the spinoff, the value of the shares of the parent firm initially drops since the assets of the parent company are reduced by the amount assigned to the new company. But stockholders receive the shares of the newly established firm to compensate them for the fall in value.
For the parent business’s current shareholders, the total value of the shares of both companies should approximately equal the pre-spinoff value of the shares in the parent company. The logic for a spinoff is that the market may provide a better worth to two distinct, but more specialised, companies compared with the value allocated to these entities while they were part of the parent company.
Companies undertake big changes as they expand, evolve, mature, or merge with another company. Some of these adjustments result in changes to the number of common shares outstanding — that is, the number of common shares currently held by shareholders. The following table outlines several business acts that can alter equity outstanding. Each of the activities and their effects are detailed in the following sections.
Company Actions That Affect Equity Outstanding
Initial Public Offering (IPO)-Company sells shares to public investors for the first time (private company becomes a public company).
Seasoned Equity Offering (SEO) -Selling shares to the public after the IPO in a secondary (or seasoned) offering.
Share repurchase - Company buys back existing shares from shareholders.
Stock dividend or stock split - Company issues new shares to current shareholders without getting any money in exchange.
Spinoff = firm forms a new firm by spinning off some existing company assets.
Initial Public Offering
The major distinction between a private company and a publicly listed firm is that the shares of a private company are available only to chosen investors and are not exchanged on a public exchange. A private firm becomes a publicly listed company through an initial public offering (IPO), which is the first time that it offers new shares to investors in a public market.
Private corporations become publicly traded companies for a number of reasons. First, it provides the company more visibility, which makes it easier to raise cash to fund expansion prospects. It also helps attract talented people, build brand awareness, and gain credibility with trading partners. In addition, it provides better liquidity for stockholders who want to sell their shares or buy additional shares. At or after the IPO, some of the initial shareholders may choose to sell some of their shares. The fact that the shares now trade in a public market makes the shares more liquid and hence easier to sell.
A downside of becoming a public business is additional regulatory and transparency responsibilities.
Seasoned Equity Offering
After an IPO, publicly listed corporations may sell further shares to raise more funds for expansion. The selling of new shares by a publicly traded firm after an IPO is referred to as a seasoned or secondary equity offering. A typical seasoned equity offering raises the number of shares outstanding by 5%–20%. For a current investor who does not buy additional shares in the seasoned stock offering, the increase in shares outstanding dilutes their ownership percentage.
Another reason why a corporation may issue new shares is to fund a purchase of another company. For larger purchases, the acquiring business may pay for the transaction by issuing new shares. The amount of new shares issued depends on the purchase price and the ratio of the two companies’ stock values. An acquisition in which the firm utilizes its stock to finance the transaction results in an increase in the acquiring company’s shares outstanding. For current shareholders in the acquiring company, the extra shares outstanding effectively dilutes their ownership proportion.
Share Repurchases
Companies may choose to return funds to shareholders by repurchasing shares rather than paying dividends. The share repurchase will boost the company’s earnings per share since net income will be split by a reduced number of shares following the repurchase. Repurchased shares are either cancelled or maintained and reported as treasury stock in the shareholders’ equity account on the company’s balance sheet. Treasury shares are not included in the number of shares outstanding.
To buy back shares, a firm can buy shares on the open market just like other investors or it can issue a formal offer to buyback directly to shareholders. Shareholders may opt to sell their shares or to remain involved in the company. For an existing investor who does not sell shares, the drop in the number of shares outstanding effectively raises that person’s ownership percentage.
Stock Splits and Stock Dividends
Companies may, on occasion, execute stock splits or give stock dividends.
A stock split is when a corporation exchanges one existing common share with a specific number of common shares.
A stock dividend is a dividend in which a firm distributes more shares to its common shareholders.
Stock splits and stock dividends both increase the number of shares outstanding, but they do not modify any single shareholder’s proportion of ownership.
When a corporation splits its stock or issues a stock dividend, the number of shares outstanding grows, and more shares are issued equally to existing shareholders depending on their present ownership percentages. Because no new money is received for the new shares, the overall worth of the company should not change. So, the price of each share will decline. But the value of any single shareholder’s total shares should not alter.
Example: Effects of a Stock Split and a Stock Dividend
Consider an investor who owns 900 shares of a business with 24,000 shares outstanding and a current share price of EUR75.00.
Stock Split
Suppose the company announces a three-for-two stock split, which means for every two shares the investor now has, they would receive three shares in replacement. So, the investor with 900 shares will get 1,350 shares after the stock split.
(900/2) x 3 = 1,350 shares
Stock Dividend
Suppose instead the firm declares a 50% stock dividend – that is, for every share investors already own, they will receive an additional 0.5 shares. In other words, the investor with 900 shares will have 1,350 shares after the stock dividend.
900 × 1.5 = 1,350 shares
A stock split or stock dividend does not modify each shareholder’s proportional ownership of the company. Shareholders do not invest any additional money for the increased number of shares, and the stock split or stock dividend does not have any influence on the company’s activities. The overall value of the company’s shares and an investor’s shares are unchanged by the stock split or stock dividend.
Given that stock splits and stock dividends do not have any influence on company operations or value, why do you think companies take these actions? One rationale is that as a firm works well and its assets and income increase, the stock price is likely to climb. At some point, the stock price may reach so high that shares become unaffordable to some investors and liquidity reduces. A stock split or stock dividend will have the effect of lowering a company’s stock price, making the shares more affordable to a larger group of investors, so enhancing liquidity.
It is vital to remember that the affordability of a company’s shares is distinct from whether the stock is undervalued or overvalued. A corporation with a stock price of USD500 per share may be unaffordable to some investors but may still be considered undervalued when the price per share is compared with the projected value per share. Similarly, a company with a stock price of USD5 per share may be accessible to most investors yet still be overvalued.
Companies with very low stock values may undertake a reverse stock split to boost their stock price. In this situation, the corporation reduces the number of shares outstanding. The fundamental reason for a reverse stock split is because a firm may face the possibility of having its shares delisted from a public exchange if its stock price falls below a certain threshold stipulated by the exchange.
After the reverse stock split, stockholders will still possess the same proportion of the shares they initially had. In other words, a reverse stock split reduces the number of shares outstanding but, again, does not impact a shareholder’s proportional ownership of the company. After a reverse stock split, the stock price should increase by the same multiple as the reverse stock split. The following example describes a 1-for-8 reverse stock split by General Electric.
Spinoffs A company may create a new company from an existing subsidiary or package of existing assets in a procedure referred to as a spinoff.
Shares of the new entity are dispersed to the parent company’s existing shareholders. After the spinoff, the value of the shares of the parent firm initially drops since the assets of the parent company are reduced by the amount assigned to the new company. But stockholders receive the shares of the newly established firm to compensate them for the fall in value.
For the parent business’s current shareholders, the total value of the shares of both companies should approximately equal the pre-spinoff value of the shares in the parent company. The logic for a spinoff is that the market may provide a better worth to two distinct, but more specialised, companies compared with the value allocated to these entities while they were part of the parent company.
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