Whether you realize it or not, you are probably well versed in supply and demand. The higher something is in demand, the more difficult it usually is to come by. The opposite is true as well. In the stock market, when the number of shares available for trading increases as a result of management's decision to issue new shares, the stock price will usually fall. While it's understandable that investors might exit a position in a stock when new shares are issued, it's also fair that a company would choose to increase its float, or number of shares available to trade.
Second Time Around
One of the main reasons that companies enter the public markets in the first place is to gain access to capital that they otherwise couldn't attract. That's not a one-time opportunity, however. Companies can return to the equity markets to raise more capital in a secondary offering. In 2013, for example, online website LinkedIn revealed it would sell $1 billion worth of new shares and the stock price plummeted nearly 3 percent in response. Before the secondary offering the stock price had climbed more than 100 percent year-to-date, and the company was likely attempting to capitalize on that price level, according to a 2013 article on the "USA Today" website.
Why Shares Sink
If a company's management decides to cash in on a rising stock price with a secondary offering to finance expansion, you'd think investors would appreciate it. There are negative effects to a secondary offering, however, that dictate otherwise. Issuing more shares dilutes the ownership stake of existing investors, meaning that their influence on major events is diminished. It also threatens to slow earnings growth, as a greater number of shares reduces earnings-per-share results, and EPS are often a proxy for stock performance.
Exceptions to the Rule
While the traditional response from a secondary offering is for the stock price to fall, there are exceptions. Sometimes good news overshadows the negative perception that can sometimes accompany new share issuance. In 2013, when the stock market was rapidly gaining value, there were more secondary offerings in the market than there had been in 15 years. One of the issuers was Restoration Hardware, whose shares rose nearly 7 percent following news of its offering after the company posted a rosy profit outlook for the year.
It's not uncommon for companies to use stock options to sweeten the overall compensation package for employees. Stock options give employees the right to purchase new shares of stock at a preset price. When a lower level employee decides to exercise her options, or buy new shares, it's not likely to have a dramatic effect on the stock price. However, high-level company officials can have a large portion of their pay tied to stock options and can therefore influence a stock price more notably when they exercise their options.
Geri Terzo is a business writer with more than 15 years of experience on Wall Street. Throughout her career, she has contributed to the two major cable business networks in segment production and chief-booking capacities and has reported for several major trade publications including "IDD Magazine," "Infrastructure Investor" and MandateWire of the "Financial Times." She works as a journalist who has contributed to The Motley Fool and InvestorPlace. Terzo is a graduate of Campbell University, where she earned a Bachelor of Arts in mass communication.