Issuing shares or buying back shares

The true owners of a company are the shareholders. When a company issue shares, the effect on the shareholders is a diluting in ownership and hence a lower percentage ownership in the company. What the shareholder is giving up, it should be compensated by means of greater growth in earnings. However, this decision is left to the management to decide the fate of the company and hence the value of the company. Management does not always act in the best interests of the shareholders.

A company should only issue shares when the company is getting more than it is giving out. If the share price is $20 and the issue of shares brings the new price to $19 as marked by the market, the funds raised by the issue of new shares should bring the company an extra net present value of more than 1 dollar per share in order to compensate for the share price drop. This can be reflected in the share price over time not instantaneously.

On the other hand, buying back shares is pretty much nothing less than awesome. If the company does not know what to do with extra cash, the best is always to buy back shares of its own company. After all, the company is run to maximize shareholder value, not to continue expanding, moving overseas or diversifiying.

I also prefer manager-owner type of companies. That way the interests of shareholders and managers are aligned. Thus one can expect the company to perform well for the shareholders over time with capable management. I am also starting to believe that management is very important to a company's success. I shall investigate this theme further in coming posts.