On the PreMarket Prep show, Dennis Dick, alongside Joel Elconin and Mitch, delved into the topic of stock dilution and its implications for stock prices. Using real-world examples like Citigroup and American International Group, Dennis highlighted how stock dilution could permanently affect a company’s stock price. This article aims to demystify stock dilution and shed light on its implications on stock prices as discussed in the interview.
What is Stock Dilution?
Stock dilution occurs when a company issues additional shares, thereby increasing the total number of outstanding shares. This increase in share count dilutes the ownership stake of existing shareholders and can significantly impact the company’s stock price. Dilution typically happens when a company needs to raise capital, often to navigate challenging financial situations. In simple terms, each piece of “pie” (share) traded now represents a smaller portion of the “whole pie” (market cap).
Citigroup and American International Group
Dennis drew attention to the cases of Citigroup (NYSE: C) and (NYSE: AIG) to illustrate the impacts of stock dilution. In their efforts to survive the 2008 financial crises, both companies significantly diluted their shares. As a result, their stock prices never returned to previous levels. As of writing this article, Citigroup is trading in the $46 range, as compared to $400-500+ before dilution took place.
These examples underscore a critical point: when a company resorts to massive dilution to survive, there’s a high probability that its stock price will never fully recover. This is because the inflated number of overall shares outstanding depresses the stock price.
Cruise Lines
In the discussion, the DDD and Joel also referenced the cruise line companies Royal Caribbean Cruises (NYSE: RCL) and Carnival Corporation (NYSE: CCL) as more recent examples. Both companies, especially CCL, engaged in share dilution to survive the financial strain brought about by the COVID-19 pandemic.
Dennis pointed out that due to the serious dilution in CCL, RCL might be the ‘best of breed’ among cruise line stocks as it did not dilute its shares to the same extent. Despite the challenges, both companies managed to secure the financing they needed, which helped them weather the crisis.
However, as noted in the show, CCL’s significant debt load still presents a considerable challenge. With $31 billion in debt against only $4 billion in revenue, the company faces a tough road ahead during periods of rising interest rates.
Key Takeaways
Stock dilution can have long-lasting impacts on a company’s stock price. While dilution can provide the necessary capital for a company to survive a crisis, it can also permanently depress the stock price. As an investor, understanding the implications of stock dilution can be crucial when assessing potential investments.
Companies with high debt loads, like CCL, can be especially risky. Even when a company manages to navigate a crisis through dilution and refinancing, the significant debt burden can still pose a threat to future profitability and stock price recovery.
Conclusion
Dennis and Joel’s insights offer a valuable lesson about the potential effects of stock dilution on stock prices. While dilution might be a necessary survival tactic for some companies, it can also lead to significant, potentially irreversible impacts on a company’s stock price. Therefore, understanding the implications of stock dilution is essential for investors, especially when making investment decisions over the longer term.
