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Issuing Shares

Previously Needed Content: Earnings, Outstanding Shares. As usual, review what you need, skip over what you know, and start building your investing knowledge.

Issuing shares is definitely a concept that even the decently well versed investors have trouble with. When investors invest in companies, the money is given to the company itself. So just like in Shark Tank when the shark cuts a check for 100k for 10%, that’s what we’re doing. But we’re poor, so we’re cutting $100 for .000000001%.

Here’s the trick though: the number of outstanding shares is not a static number. Companies can issue more shares and raise capital by increasing the number of outstanding shares, usually close to the current stock price (maybe a slight discount). Why would a company do this and how does it affect the shareholders?

If you remember, as you increase the number of outstanding shares, the earnings per share will decrease because the company is still making the same amount of money but it’s being divided among more shares or pieces of the company. BUT, if the company with that raised capital invests it or buys assets that INCREASE the earnings of the company by more than the dilution of increasing the number of shares, the shares after the share issuance are actual more valuable. This is a hard concept…to the kitchen.

EXAMPLE: PEPPERONI PIZZA

Now, say you love yourself and you love pepperoni pizza. You’re a meataterian, so all you want is the most amount of pepperoni as possible, screw the crust. The pizza is cut into four slices with eight pepperonis, and you and your friend split it in half.

SUMMARY: 8 Pepperonis, 4 slices, 2 Pepperonis/Slice (Earnings Per Share?)

Then, one of your meat head friends comes over and asks…Hey if you cut up the pizza into 8 slices instead of four, I’ll add 16 pepperonis to the pizza.

OFFER: 24 Pepperonis, 8 slices, 3 Pepperonis/Slice (EPS Grew?…)

So, even though you cut up your pizza into more slices and your amount of pepperonis were cut in half, the Pepperoni per slice went up. This is exactly like issuing shares; if you issue shares, raise capital, but end up making more money on that raised capital, then each share has more earnings, or profit, and each one then is more valuable and will go up in price.

HOWEVER, if that pepperoni dude only came over and offered 8 pepperonis or less then the amount of pepperonis/slice would stay even or even go down. So, if companies are issuing shares then make sure that they’re going to projects that will increase earnings in the long term.

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