By printing up more shares, companies do two primary things: (1) raise more money, and (2) dilute existing shareholders. Let's take an example, a public company has 100 million shares outstanding and trades at $25 per share. The market capitalization is therefore $2.5 billion. Now let's say the company wants to raise $250 million to make an acquisition or pay off long-term debt. The company announces a secondary offering of 10 million (new) shares. When the offering happens, the company will wind up with 110 million shares, having raised $250 million through the sale of those 10 million new shares. Often, the stock price will drop some to account for the greater supply of shares backing the same enterprise.
To do the offer, the company needs to set a price. It is probably close to market price, but existing shareholders can see the additional shares as diluting earnings (unless the funds are used to generate additional earnings promptly or to pay down expensive debt, etc). So market price can respond positively or negatively to the new offering. Management probably takes the pulse of a few shareholders to judge in setting the offering price, but no one really knows until the offer is public.
As to how this affects your investment, read the prospectus and/or news releases and listen carefully to what they plan to do with the funds. If they will be used profitably it can be good for the company and your stock. But short term, earnings per share can lag due to more shares and earnings not kicking in immediately.
Related Motley Fool Investment Guide Quotation
"The second way [that shares of ownership in a public company end up in the hands of former nonowners] is for those public companies that have already had an initial public offering to acquire more capital to fuel future growth. They make a secondary offering.... Issuing more shares dilutes the existing value of the shares held by the previous owners, as it creates more units of control, but for a growing company this is normally not a problem.... Most of the companies that with a couple hundred million shares started out with only a few million. They kept going back to the well for more cash, though, and they split their stock." (p. 245)
- Initial public offering
- Market capitalization
- Public company
- Stock watering
- Watered stock
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