How does that work, exactly? Tone: Honest question. I don't understand how a company could create new stock for itself, since it seems like that would therefore dilute all current shares and thus being almost by definition against the interest of all current stock holders and therefore something they would not permit. (I say this not to argue it is therefore impossible, but to highlight what misperceptions I may have that need correction.)

Now back to the stock incentives programs. Here you are issuing stock and giving it to your employees. Assume you had to give then X$ in cash as compensation, you could just do the same as before, raise that money in the market and give the cash to them. You might as well do it in one step giving them that value in stock and get the added benefit that those employees are now financially invested in the outcome of the company.

Buybacks (and dividends) are indeed neutral to shareholders. You have a company that's worth Y and you buyback X$ using company cash, the shareholders now have in their hands a company that's worth Y-X and X$ in cash, for a total of Y.

If, however, you believe that the market is 100% efficient and the price is always just right, then both of these actions will be neutral to shareholders.

The market is saying one thing. You believe another. So you bet against the market and the end result is... no change that affects shareholders?

If that were true, why would a corporation do this?

At the moment of the transaction there's no change, you've just swapped money for stock and could swap it back the moment after and be back to square one. If you are right and the market is wrong you'll make money on the transaction in the long run. It's just like buying stock for your own account. The moment you buy your net worth doesn't change you've just changed your asset mix between stocks and cash and could change it back with a sell order. Only by the stock changing value over time do you gain or lose net worth.

PS: Starting your comments with "No." doesn't really add much to the discussion.

While it does not affect the line item "shareholder's equity" it very much does affect individual shareholders.

It is not a magic wash covered by some "perfect market" force and shareholders will very much complain about dilution. This was OP's question and you've repeatedly talked in circles around it.

Think of the simple case - a company with $100 cash, and 100 shares, with a value of $1/share.

You buy 75 shares for $75. You now have 25 shares outstanding, and $25 cash. Still, $1/share.

Alternatively, you can issue 100 shares @ $1/each. You now have $200 cash, and 200 shares outstanding.

Share Buybacks/Share Issues (not including tax consequences), are neutral transactions.

Shady Patents, Inc has 10 shares outstanding. Current price is $1/share. I own one share.

They issue 90 more shares at $1/share.

Yes, duh, shareholder's equity remains constant. Shareholder DILUTION however is substantial. If they collect $1 million on a patent and issue a special dividend, I'm getting $1,000 instead of $100,000.

YES, there's an equal credit and debit on the balance sheet. NO, this does not mean the market will prop up the price. OF COURSE issuing shares is going to create downward share price pressure. If it didn't, companies would just issue shares indefinitely. And yes, to back up what poor OP said six hours ago, shareholders often resist dilution.

Clearly that payout was not priced into the original share price a the time of the capital raise so the new shareholders indeed got a great benefit at the expense of the old ones. At the moment of the transaction though the company went from being valued at 10$ to being valued at 100$ and for that to happen 90$ in cash was added to the company. The company could have turned around and used the same 90$ to buy back the same shares, which is why the transaction itself is neutral to shareholders. As the share price changes over time that may turn out to be a good or a bad idea.

I never said market cap equals cash on hand, I'm talking about the normal valuation of the company. You have a company that is valued as a whole at 10$ by the market, not just cash, everything. You raise 90$ of capital by issuing 90 new shares, bringing the total up to 100 shares. That company is now worth the original 10$ plus the new 90$ that were put in. So it's worth 100$ in total and still 1$ per share. This is just the basic math of a capital raise or dividend/share buyback, there's no way around it.

More germane to HN: I'm a founder. I own 50.01% of my company. Issuing stock is a "neutral" event for me because I'm going to own a smaller piece of a bigger pie? C'mon dude, admit you're wrong and move on.

No I'm not. I've always referred to market cap, never accounting.

> I'm a founder. I own 50.01% of my company. Issuing stock is a "neutral" event for me because I'm going to own a smaller piece of a bigger pie?

At the moment of the transaction yes, it's neutral. You could use the money you just raised to buy back the shares you just issued and be back to square one. That's all I am saying and it's a basic point taught in finance classes. In fact if what you suggest happened, and the share value tanked you'd have a perpetual money making machine. Just raise a bunch of capital, watch your stock tank, buy back shares and end up owning the whole company again plus some left over cash.

That doesn't mean that raising capital can't in the long term add or destroy value in a company, it's just not the transaction that does it, it's what you do or don't do with the money. If you use the money so that the total employed capital has a higher rate of return than just the original one, the value goes up, if not it goes down.

Also, you can't put the genie back in the bottle and buy back as you keep proposing. Because the market gets its say. Even if there were sufficient liquidity (shares available to purchase) there's no reason to expect the price would remain constant. And if I own 49.9% and BigCorp owns 50.1%, you can imagine that share price is not going to be "pedrocr math." The world doesn't work like a basic bookkeeping class.

Ok, so what price would the market set for a share in the company we discussed before? Assume the original 10$ valuation was fair and that there are now 100 shares after issuing 90$ worth of new ones. What's the new price? Above or below 1$?

However I went from holding 10% of a company to 1% of a company. If I was holding the stock because I thought the company would sell for 100x my investment -- $100 sale to a competitor and that I'd get $10 -- well, now I'm a 1% owner and it doesn't seem like they're going to sell. And I'm also not likely to be interested in holding a $1 stock for potential payoff of $1. (Since I know their burn rate is $10/month and now increasing, I don't give a damn about the cash on hand, never did.)

How about other scenarios?

a) The company announces it's entering a brand new, high-risk market and it's issuing 90 new shares on the open market. Market opens. What's the price?

b) Same as a) but company announces it will be suspending its dividend for 1 year. Market opens. What's the price?

c) Company announces that it entered into a strategic marketing agreement with Salesforce in exchange for a private issue of 90 shares at $1. Market opens. What's the price?

d) Company announces it granted 90 options to its new star CEO and issued 90 shares to cover. Market opens. What's the price?

e) Company announces it borrowed $90 from Warren Buffett at 10% interest and also gave him warrants for 90 shares at $1. Market opens. What's the price?

> I've always referred to market cap, never accounting.

Not true. Which is why my next test question was going to be: the company went public at $10 last year before dropping to $1. So there's $190 in shareholder's equity against 100 shares and $90 cash on hand. Market opens, what's the price?

The core flaw of your argument is that the company can't control the market price. So there's no such thing as a "neutral market cap" transaction that changes the number of shares and you certainly can't "undo" it just because the numbers line up on the balance sheet. Specific to your core error, look up P/B ratio.

This whole thread apparently got linked from elsewhere and "We've limited requests for this url" is the error given. It's been fun guest lecturing here but I believe our overlords signaled that it's time to free up resources.

For anyone who's followed this long, read "Security Analysis" by Benjamin Graham for real insights instead of this incomplete thought experiment gone awry.

This is just rude as have been other posts. I haven't made any excuses, just arguments, which you have generally failed to engage and just thrown in more and more complexity into the mix.

> but the answer is: whatever the market decides. I've decided I want to sell my share. I now have to find someone willing to buy it. The spread alone guarantees I'm not going to get $1 for it.

Congratulations, you've found a way to extract free money from the market:

Cenario A: The transaction happens and the price is now above 1$. Great, there is now at least one person out there willing to buy a share for more than 1$. The initial shareholders should be ecstatic, just taking 90$ in exchange for 90 shares has allowed them to sell at least one share for more than 1$, whereas yesterday they could only get 1$ for them. Free money!

Cenario B: The transaction happens and the price is now below 1$. Great, there is now at least one of the shareholders (new or old) that is willing to sell one or more shares for less than 1$. Take 1$ from the 90$ you just raised and buy back the share. The remaining shareholders get to keep the change. Free money!

This doesn't mean that movements in price can't accompany capital raises. But what causes that movement isn't the transaction itself it's what it means. If a bank suddenly announces it has raised capital to cover larger than expected loan defaults the share price will decrease, because of the defaults not the capital raising transaction. If a manufacturing company announces it has raised capital to increase it's capacity in a booming market, the price may very well rise, not because of the capital raise, but because the expectation is that the company will be more profitable in the future.

The point, and this is my final comment, is that raising capital doesn't by itself change the share price of the company, but what the transaction implies may very well do. In the bank case the revelation of past problems lowers the price, in the manufacturing example the expectation of future profits does. Never the transaction itself which is the same in both cases.

> For anyone who's followed this long, read "Security Analysis" by Benjamin Graham for real insights instead of this incomplete thought experiment gone awry.

The book recommendation sounds great to me. I'd add the recommendation for a good finance textbook as it may help find some of those mispriced opportunities that Graham talks about. If you suddenly find a company that has just raised money being valued at less that previous_value+raised_money it may pay to look into if there's an opportunity or if there's a reason the price is lower (the expectation that the company will blow through the money without generating enough profit).

First, I think your example of dilution and it's impact on returns is a good one.

Dilution - a nice neutral definition can be found here:

http://www.investopedia.com/terms/d/dilution.asp

A reduction in the ownership percentage of a share of stock caused by the issuance of new stock. Dilution can also occur when holders of stock options (such as company employees) or holders of other optionable securities exercise their options. When the number of shares outstanding increases, each existing stockholder will own a smaller, or diluted, percentage of the company, making each share less valuable. Dilution also reduces the value of existing shares by reducing the stock's earnings per share.

I sense we were overly focussed on the impact to the balance sheet, and ignoring the impact on share of earnings, so I will grant you that Dilution's impact on EPS (and, eventually share of dividends), is a reason that shareholders might resist Dilution.)

But, I think it's important to recognize a couple things. First, issuing shares does not always create downward share price pressure. It's quite often the case (particularly in startups), that an infusion of cash has a significant upwards impact, as the liquidity may now make the company much more valuable.

Another good example might be Apple, back in 1997. Microsoft's $150 million got 150,000 shares of stock. That liquidity injection (at a pre-split price of $2.50) gave Apple an important boost at an important time - that I would argue created upward share price pressure.

On the flip side - http://www.investopedia.com/articles/stocks/11/dangers-of-st... has a nice writeup on how to deal with issues surrounding dilution.

Specific to the MSFT/Apple deal you mention -- and more notably as part of Warren Buffett's deals with GS/BofA/GE -- those were preferred and non-voting shares. So there was no dilution in either EPS or voting control.

Microsoft re-assuring that it would continue to produce Office for Mac affected the price. Apple taking out what was effectively a $150 million loan at 6% interest was not the source of the excitement.

Buffett's deals also included warrants. I can no longer devote time to being the thread savior here but I'd encourage anyone reading this to walk through those deals and think through the implications. It's pretty interesting stuff.

As any startup founder knows, the art is to issue just enough shares to fund the company to grow to success -- and in fact, to do this in stages, each time issuing only enough shares to make it to the next milestone.

In practice, for large companies, the quantity of shares issued is generally small and gradual enough that any dilution is factored in gradually to the share price.

1) The mechanism by which you move money in/out of a company. At the moment of the transaction you add/remove X$ in cash to the company and add/remove the same X$ in shareholders. You could turn around and use that same cash to do the opposite transaction and be back to square one. That's what I mean by the transaction being neutral to shareholders.

2) The situations in which you are incentivized to do these share issues/buybacks and their long term impacts. If you believe that your company is currently valued at Y but is really worth 10Y then you want to raise as little as possible to get a bigger share of that 10X increase in value. Conversely if you think your share is overpriced you want to raise as much as possible because you are paying it with inflated shares.

The transactions themselves are neutral to the shareholders at that point in time, they're just ways of moving cash in/out of the company, you do them more or less and in one direction or another depending on your evaluation of how mispriced the company is.