According to the Schweser notes it’s said “Issuing equity is typically viewed as a negative signal that managers believe a firm’s stock is overvalued”.
I do not see any explanation of it. Can anyboby help me?
Here is an (imperfect) example. Would you rather sell a $5 bill for $4 (we will omit $5 bill for $5) or $6? In an IPO or SEO, the firm raises money. If management believes the shares are overvalued, a good time to raise money through equity (for the firm and for current shareholders) is when the market is has overvalued the stock (selling $5 for $6). If the firm issues stock when it is undervalued, they would be giving something away for less than it’s worth (detrimental to original shareholders, selling $5 for $4). In a world where asymmetries exist, many people believe that the issuance of debt/equity is a way to get management-level insight on the firm’s prospects and value.
Now I got it!!!
Thanks a lot.
I didn’t read the above example, but simply, issuing new equity dilutes current shareholder value. Economically, it increases supply of the issue for a given demand driving down the price.
Furthermore, equity financing is more expensive than debt financing. Therefore, to justify issuing new equity, a firm must believe that they’re getting more money than they ought to be getting (thereby reducing the effective financing rate).
By reading this, 3 words accross my mind : Pecking Order Theory
This.
As long as ROE stays at least the same, and above the Ke, then it shouldn’t lower the stock price. Assuming it was fairly priced to begin with.
buy low, sell high = also applies to companies buying/selling their own stocks.