- Investment strategies
- Why invest in the stock market?
- Buy and hold or technical analysis? Why you need an investment plan
- Value investing and short selling in volatile markets
- Using technical analysis to support value investing
- Investing in the unexpected
- Franking credits, explained
- What is dividend stripping and is it a sensible strategy?
- Investing in quality IPOs
- How to invest in stocks that benefit from a moving Australian dollar
- Reasons to avoid bonds when interest rates are low
- How value investors use Skaffold
- Quality, growth and value = a winning strategy
- Know your investor type and boost your performance
- Technical + fundamental analysis = better buy and sell decisions
- Fundamental investing
- Value investing and the price earnings ratio
- Intrinsic valuation models and methodology
- Value investments or value traps?
- How to find value stocks in a bull market
- Find value investments in expanding markets
- Why capital raisings struggle to add investment value
- How to value an insurance company
- Top stocks
- 5 qualities of top stocks
- How to find stocks with a competitive advantage
- Why return on equity is the best measure of business performance
- Using cash flow to find value investments
- Finding high quality dividend stocks
- Debt is not always a dirty word
- Why Skaffold share investment software makes sense
- Using economic factors to uncover the best investment options
- How do experts find top stocks to invest in?
- Investing in global stocks
- How to invest in international shares on global stock markets
- Benefits of investing in international shares
Why capital raisings struggle to add investment value
Capital raisings can shore up a company’s reserves and pay down debt, but they also risk diluting shareholder value.
Ideally a capital raising should deliver the classic ‘win-win’ by shoring-up capital reserves and paying down company debt while offering shareholders more shares at attractive discounts to traded prices. Unfortunately the benefits of capital raisings can be extremely one-sided. That’s why it’s important to understand that all capital raisings are not equal, and can destroy value for shareholders.
By learning how to identify an unfair capital raising, you (the shareholder) can avoid potential dilution in your shareholder value and being diddled out of your cash.
Higher share prices, lower debt – what can go wrong?
It’s not uncommon for a share price to rally following a capital raising – typically due to a quick mop-up of any perceived overhang in the market – and when it does shareholders are happy with their immediate windfall. But long-term wealth generation is a different matter, and it can sometimes take years to identify whether attempts to repair the balance sheet did add value.
A capital raising may indeed reduce company debt, but if it doesn’t result in increased earnings, the long-term value to shareholders is questionable. A capital raising may dilute earnings per share (EPS) in the hope that the future earnings impact will be positive, but this outcome is never guaranteed.
So if a capital raising has resulted in a material decline in intrinsic value, then sustainable price increases look less bankable. That’s because in the long run a company’s share price and its intrinsic value are destined to converge at some future point.
Share price rises may not last
It’s not uncommon for the share price to gravitate towards lower valuations following a capital raising. When equity increases and the company doesn’t manage to raise profits by a proportionate amount, return on equity plummets. Just look at Wesfarmers (WES) in 2008, Newcrest Mining (NCM) since 2011 and BlueScope Steel (BSL) in 2009.
In 2008 Wesfarmers added $15,941.00 million in equity to its business. That year return on equity fell to 12 per cent, from 25 per cent the previous year. By December 2008, the year of the capital raising, WES’s share price had fallen to a low of around $14.50. It had traded around $35.00 between 2004 and early 2008.
Skaffold's Capital History Evaluate screen shows WES’s 2008 capital raising
Newcrest Mining (NCM)
Newcrest added more than $2 billion in 2008, and another $10 billion in 2011. Each time capital was raised, return on equity fell. Between 2007 and 2008 ROE halved, from 12 per cent to just over 6 per cent. In 2011 ROE was 11 per cent compared to 17 per cent in 2010.
Skaffold's Capital History Evaluate screen shows NCM’s 2008 and 2011 capital raisings
As a savvy investor, you need to ask yourself how any company could be so desperate for capital that it’s prepared to dilute existing shareholders so unashamedly?
Renounceable entitlement offers
While there are many types of capital raisings, one of the cleanest and most popular is where you (the shareholder) are offered shares at a fixed price, or rights issues, in proportion to the shares you already own. These offers, often called ‘renounceable entitlement offers’ can be sold on the market, under the code ‘ASXR’.
What makes a renounceable entitlement offer of value to you (the shareholder) is the difference between the ordinary share price and the offer price.
You’re not obliged to take up your renounceable entitlement offer, but remember loss of value is a by-product of issuing shares at a price discount. So by not participating, you’ll fail to offset the (shareholder) ‘dilution factor’ – a by-product of capital raisings that involve issuing more shares – unless the company has made other arrangements.
Share purchase plans (SPPs)
Beyond renounceable entitlements, the next most common form of capital raising is via a share purchase plan (SPP), which unlike a renounceable entitlement capital raising is not required to issue a prospectus. An SPP is an offer (at a discount) limited to a maximum $15,000 worth of shares per shareholder in a 12-month period.
While this fixed dollar amount is great for smaller shareholders, it disadvantages those with considerably larger shareholdings. However, if demand is high – as is often the case on popular SPPs – no shareholder will receive anywhere near their $15,000 worth of shares due to severe scaling back.
A third, and considerably less transparent, capital raising option is called a placement, whereby large shareholders (typically institutions) get to buy shares at a discount. However, if smaller shareholders are not given the right to participate in an SPP alongside a placement, then the value of their holding is diluted.
Don’t let capital raisings turn you from value investor to speculator
At face value, a rights issue can create opportunity to mitigate any dilution, assuming market capitalisation doesn’t change. But the trouble with speculating on this outcome is that it runs counter to what happens in most instances. It’s equally important to remember that if your goal is to capitalise on the spread between issue price and traded price, you’ve fallen from investor to speculator – and winning at this game requires fast footwork.