How Secondary Stock Offerings Affect Stock Prices

When the market inhales these secondary offerings, you know it's a good sign.

Chalkboard says Investing 101

One of the most memorable and exciting parts of fishing is when you see a big fish follow your lure … and absolutely inhale it.

It’s like you can see the entire aquatic environment around your bait get sucked into the fish’s mouth and disappear, as if it was never there to begin with.

A plastic worm lure doesn’t help a fish at all, but when they inhale wild bait, like crayfish and minnows, they get stronger and have more energy to pursue life-sustaining activities.

The stock market analogy to a big bass inhaling a meal is a well-received secondary stock offering, or a well-received convertible note offering.

In these scenarios, a company announces it will raise capital by issuing new shares to the public (secondary stock offering) or by issuing low interest-bearing notes that can be converted into shares, usually within five to 10 years (convertible note offering).

The company completes the offering at an attractive price and the shares are quickly absorbed by the market.

In fishing terms, the market “inhales” the new shares. And the stock’s trend continues, more or less as it had been prior to the secondary offering. Management pursues growth initiatives with the new capital.

Both traders and longer-term investors view a well-received secondary stock or convertible note offering as a bullish signal.

The well-received secondary stock or convertible note offering is an especially strong buy signal for certain small-cap stocks and early-stage growth stocks. That’s because it signals huge demand for a stock that still has a relatively small public float and/or is growing rapidly.

If the market thinks a company is issuing shares to raise cash for good things, like attractive acquisitions, to fund new product development, to expand a sales team to meet demand, etc., then a stock can easily go up after the announcement.

In this bullish scenario there are many investors that are eager to buy the newly issued shares (or notes). And they get inhaled by the market.

Is a Secondary Stock Offering a Bad Thing?
Too many investors think a secondary stock offering from a growth stock is a bad thing. In some cases, they are.

There are far too many examples of companies that issue shares of stock just to keep the lights on and to meet payroll. These stocks, which are usually bad investments, usually trend down (or at best sideways) before, and after, the offering because management is destroying value.

But don’t assume all secondary offerings are bad just because some are.

There are also many examples of small-cap stocks and early-stage growth stocks that complete secondary stock offerings because it is the most efficient way to raise growth-fueling capital.

Investors would be well served to keep an open mind and watch how the stock handles the secondary.

If the market inhales it, you might want to consider buying too.


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