Many newbie investors get in trouble because they don't understand the relationship between share price and share count. If you're new to investing and you've never heard of "dilution," it's very important that you keep reading this post.
If I look at a standard chart of Spirit Airlines's share price, such as a upper chart above, I might conclude that the stock is cheap right now. Spirit shares are trading well below the price they've traded at for the last five years.
This is an illusion. The valuation of a company is its share price times the number of shares outstanding. When a company runs low on cash, it sometimes issues and sells new shares. This "dilutes" the ownership percentage of existing shares.
Imagine I have a pie, and I've invited you and two other people over for a piece. We're each going to get a quarter of a pie-- a really big slice! But then you decide to invite a friend. The size of the pie doesn't change, so now we have to cut it in fifths so your friend can have a slice. Each of us will get a smaller piece.
Issuing new shares works the same way. Since the beginning of the Covid-19 pandemic, Spirit Airlines has issued 29.14 million new shares, increasing its share count by 42.5%. That means that each share now represents a much smaller proportion of the company than it used to. The shares have been "diluted."
Because of dilution, looking at a chart of the price of a single share doesn't tell you how "cheap" or "expensive" a company is compared to its historical valuations. Fortunately, there's a quick and easy way to chart a company's actual valuation.
Share price multiplied by shares outstanding equals the company's total price tag, its "market capitalization" or "market cap." To chart market cap on TradingView, find and click the button labeled "fundamental metrics for stocks" at the top of the chart. Type "market" in the search box, and TradingView will narrow the list of metrics down to the one you want. Clicking on "market capitalization" will add a time series of the stock's market cap to your chart.
When we look at market cap for Spirit Airlines, it doesn't look cheap anymore. Spirit is trading within its price range of the last four years, even though the company is now financially worse off in every way. With earnings negative and sales nearly cut in half, Spirit is priced as if the pandemic had never happened. By charting market cap, you've adjusted for dilution and gained a much better understanding of the asking price.
Great explanation....please explain this to Tesla holders !!
Protixder
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@kaptkorea, yes great one
Protixder
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@kaptkorea,
AllanCharts
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I am not commenting too much on the valuation and fundamentals of TSLA stock, but TSLA only diluted 1% of its holdings. A far cry from the 48% in the Spirit example. Looking at the balance sheets of the TSLA and SPIRIT there are very different stories being told. Which, may account for why share holders barely blinked at the capital raise. Perhaps the narrative in an investors mind is that TSLA will also use the capital more efficiently to rapidly scale, while SPIRIT is more likely to using it to cover major losses. Just thoughts....
ChristopherCarrollSmith
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@AllanCharts, there's also a pretty big difference between issuing shares into an uptrend and issuing shares into a downtrend. If a company is going to raise cash, it should do it at its leisure when the stock is expensive rather than under pressure when the stock is cheap. Tesla's decision to issue shares here essentially "locks in" some of the price inflation by converting it to cash. In my opinion it's a clever move.
@kaptkorea, can you explain why In the tesla chart I see that its price and its market capitalization are on par, thanks
ChristopherCarrollSmith
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@liforex, the share offerings on Tesla have been small relative to the company's total market cap, so you have to be pretty zoomed in to see the effect. For instance, the last share offering increased the total common shares from 930 million to 948 million. The company's $400 billion market cap increased by just $8 billion, or about 2%.
iTzRaDiaNT
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@kaptkorea, Agree :)
JMaddison
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But when you issue more shares the total value of the company also increases. If a company has a valuation of $100 dollars and it's made up of 100 shares then the value per share is $1. If you then issue 10 more shares, you bring in $10 into the business. It's now worth $110/110 shares so still equals $1 per share. Even if you have a fifth instead of a quarter, the amount of pie is the same.
The share price may decrease, but this more likely reflects the fact that shareholders are now taking on less risk than they were previously because the business has more assets, and because they're sharing the risk with others.