The problem with equity financing

[Steve]

Investor Philip Fisher, was concerned about how companies paid for their growth. To finance growth, he saw that a company could choose from two options. Either they could pay for it with company profits or by selling stock in the company. The problem, he felt, with companies that paid for growth through equity financing was the larger number of outstanding shares this created would cancel out any benefits the equity financing paid for. Instead Philip preferred to invest in companies that had higher profit margins and could self fund company growth from profits. By self funding, the growth that came more organically from within, and that growth would not be diluted by a larger number of share holders. Think about how this applies to you and your business. Would you rather sell your uncle a % of your business for a $5,000 loan for a mower or would you rather use money you earned throughout the year to purchase it? If the goal of purchasing this new mower is to help you cut a lawn faster and therefor make more money during your workday because you are cutting more lawns, what good is that extra money if you now have to give your uncle a certain percentage of your profits because he is now a part owner in your company?

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[The Cleaning Doctor]

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Very nice post Steve. One book that I was reminded of today, I would recommend reading is.... Sam Walton, Made in America

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[Hedgemaster]

I'm "self funding" my growth by applying for a credit card with 0% interest for 15 months.
It arrived today - time to buy a mower.



Screw Uncle Bob.

[picframer]

Depends, Equity financing is critical and the #1 route the majority of stocks that trade on stock exchanges and over the counter raise equity for operations and growth as it is the most cost effective way to do it. The ROE for the investor can be multiples vs investing in companies that raise capital through debt, plus the risk is far lower to the investor as the company that raises capital through equity does not have the debt obligation payments.

As for over capitalization due to issuing shares to raise capital, I don't buy it. It's all relative to the investment, what the cash will be used for (growth, new product etc) when capitalization is large and you want to increase the price of the stock you do a reverse stock split.

As a banker in syndication, I have personally handled hundreds of equity placements and even did them in companies I own.

[Steve]

Depends, Equity financing is critical and the #1 route the majority of stocks that trade on stock exchanges and over the counter raise equity for operations and growth as it is the most cost effective way to do it. The ROE for the investor can be multiples vs investing in companies that raise capital through debt, plus the risk is far lower to the investor as the company that raises capital through equity does not have the debt obligation payments.

Do you feel there are public companies out there that are able to self fund growth through profits?

If so, are these better companies to invest in or no?

[picframer]

Originally Posted by Steve

Do you feel there are public companies out there that are able to self fund growth through profits?

If so, are these better companies to invest in or no?

Many do, perhaps once they get their feet under them, most do. However when a company wants to take on serious growth because of an opportunity, generally they will issue equity so that they are not carrying debt obligations should something go wrong, thus the risk to the investor.

As for what is the best to invest in, there is no clear cut answer, every investor is different and here in Canada you do a risk evualation and that will tell you the types of companies you should be looking at. generally younger people with disposable income will take larger risks than say someone in their 50's as they are looking at long term growth as the person 50 wants med risk as they are getting close to retirement, someone 65 will want fixed income with little to no risk.

[Steve]

As for what is the best to invest in, there is no clear cut answer, every investor is different and here in Canada you do a risk evualation and that will tell you the types of companies you should be looking at.

Very interesting! Does this apply to stock investments or is this more for mutual funds?

What kinds of questions are asked in such an evaluation?

[picframer]

Originally Posted by Steve

Very interesting! Does this apply to stock investments or is this more for mutual funds?

What kinds of questions are asked in such an evaluation?

Generally speaking mutual funds are lower risk as you have a mixed bag of equity within the fund, i.e. not putting all your eggs in one basket.

My son who is last year in University (CFA) finished a modul in equity trading before Christmas, it was aa topic of deep discussion over the holidays. Once you understand the market, you may be like me, share prices are more often than not driven by spec vs how well the company is doing. So when you look at a company, you have to factor heavy what the market reaction is to events that may effect that company.

I'll use something simple and dear to us all which makes my blood boil. Canada has vast oil reserves, we are the largest supplier to the USA in the world, now our oil prices here are based on what the spot price is on the NYSE, the NYSE is driven by fund managers following world events.

Oil is currently at record levels again, however our country is self sufficient yet we are paying these rates because of what is going on in the middle east even though the USA and Canada do not purchase any quanity at all from Lybia which is the hot spot at the moment. It makes no sense.

I have seen share prices go through the roof because of market hype, I have seen shares drop to almost worthless prices simply driven by investors who thought something may be bad news for the company when in fact the company was doing fine.

Speculation by income managers swing the market big time, thus no easy answer.

[wandfsmall]

financing is what kills most businesses. I am a debt free company, it takes forever to grow this way but it does not come down very fast either. It also allows me to offer lower prices then my competitors that have million dollar buildings. I understand borrowing money for equipment but keep that to a minimum and you will be standing when all of the lowballers around you take out your competitors.

[Steve]

Generally speaking mutual funds are lower risk as you have a mixed bag of equity within the fund, i.e. not putting all your eggs in one basket.

Now with these mutual funds, are most of them a collection of stocks and bonds? Are they not traded constantly by the mutual fund manager?

The thing I wonder is this, if you invest in a mutual fund in efforts to lower your investment risks, because your money is spread out across many stocks and bonds, through this mutual fund. If the market decreases in value, a mutual fund manager will try to buy and sell his way out of losses. Because he does this, when the market swings up in the future, won't you lose out on much equity because the mutual fund traded a lot of stocks?

So if instead of investing in a mutual fund, say you parked your money in, for instance, a walmart stock that doesnt seem to move much. Even if the stock market as a whole went down, as long as you left your investment alone, the underlying business principles of Walmart are not going to change, so as the market picks up, your walmart stock value will too. When it does, you wouldn't have lost out as you would have with an investment in a mutual fund?