Is an increase in the share capital of a company a bad sign?
An increase in the total share capital on a company’s balance sheet is usually bad news for shareholders because it represents the issuance of additional shares, which dilutes the value of existing shares for investors. However, the additional equity capital can benefit investors in the form of an increased return on equity through capital gains, higher dividend payouts, or both.
What is share capital?
Share capital is the total amount of shares, both ordinary and preferred, that a public company is authorized to issue. The difference between common stock and preferred stock is that if a company goes bankrupt, preferred shareholders receive their share of the assets before common shareholders receive theirs (if anything is left).
Common stocks are what investors usually buy, and companies don’t always offer preferred stock. Note that even if a company begins its life with a certain number of equity shares, it may authorize the creation and issuance of additional shares if approved by the board of directors and existing shareholders.
Share capital is the number of shares that may be outstanding or owned by shareholders. The amount of share capital that a company issues is usually initially stated in the company charter, which is the legal document used to set up a company. However, a company generally has the right to increase the amount of shares it is authorized to issue by the approval of its board of directors. In addition to the right to issue more shares for sale, a company has the right to buy back existing shares from shareholders.
Investors can find information about a company’s share capital in the equity section of its balance sheet.
Disadvantages of increasing the share capital
Increases in total share capital can have a negative impact on existing shareholders as they usually result in dilution of shares. This means that each existing stock represents a smaller percentage of ownership, which makes the stock less valuable.
As the company’s earnings are divided by the new larger number of shares to determine the company’s earnings per share (EPS), the company’s diluted EPS figure will drop.
Investors and analysts are wary if a company continually launches additional stock offerings, as this often indicates that the company is struggling to maintain financial solvency with current revenues and is in constant need of additional funding.
Benefits of increasing the share capital
Despite a possible dilution of the shares, increases in share capital can ultimately be beneficial for investors. Increasing the capital of the company raised by the sale of additional shares can finance additional growth of the company. If the company invests the additional capital successfully, the ultimate gains in stock price and dividend distribution realized by investors may be more than enough to offset the dilution of their stocks.
It is a good sign for investors and analysts if a company can issue a significant amount of additional shares without seeing a significant drop in the share price.