Selling stock is a way for corporations to generate a source of funding that can be used to grow the company. However, stock prices can fluctuate when they are publicly offered, and corporations that issue new stocks can dilute the shares and potentially cause their value to drop. Since stock offerings are used to fund company operations, they can also spur corporate growth and improve earnings, producing long-term benefits for shareholders.
Initial Public Offerings
Private companies or limited-ownership small corporations will look for new revenue sources to fund growth. By going public and selling stock to investors, companies can incorporate and potentially raise large amounts of capital. When a company incorporates, it works with a bank or other financial institution to “underwrite” the stock. Together, they set a target price for the shares and find a stock exchange on which to list it. The stocks are then released to the public in an initial public offering, or IPO.
IPO Stock Prices
Individual investors usually aren't able to get an early chance to buy into an IPO unless they have large accounts, with the financial firm underwriting the IPO. Hedge funds and other institutional investors will often make large-scale purchases and drive up the stock price immediately following the IPO, writes CNBC. The stock price can drop in the days after the IPO, however, so CNBC recommends that investors evaluate the stock’s price for a few days before buying.
The outstanding shares of stock are the shares owned by the public, corporate directors or employees. Corporations issued the outstanding shares from a pool of authorized shares, which is the maximum number of shares a corporate board of directors can distribute before the stockholders must approve a new sale of shares. Most corporations don’t distribute all of their authorized shares, leaving some available to sell if the business needs to raise funds for paying down debt, financing operations or to buy out another company. If a corporation offers more of its authorized shares for sale to the public, it is called a secondary offering and can generate both benefits and problems for stockholders.
The immediate result of a secondary offering is that it dilutes the value of the shares. Since shares represent a percentage of ownership, the secondary offering lowers the ownership stake and can result in a lower share prices initially. However, secondary offerings can be beneficial to investors who believe the company will continue to grow. Companies that reinvest the funds into a project that improves their growth or performance may in turn boost earnings as well as the share price. Corporations will use secondary offerings when they lack financing, generally because stock prices are already low, according to Daily Finance. Many investors believe that a secondary offering is a signal that the stock is weakening.
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