Learn Stock Market Investing

We’ve already discussed dividends as a way on how you can make money in the stock market (Part 1). We’ve also discussed the second way on how you can make money in the stock market (part 2), which is through capital appreciation. Now we proceed with the third.

3.) Stock Rights offering

The third way wherein you can make money in the stock market is through ”Stock rights offering” Stock rights offering is the option given to the existing shareholders to buy additional shares of stock at a price usually lower than the existing market price. In other jurisdictions, other terms for this are pre-emptive rights, subscription rights and oversubscription privilege.

So why would the company offer a “stock offering”? What is this all about? In order that you could understand this more simply, I will give you an illustration. Imagine that you and I will go into the business of selling barbecue, so we setup a barbecue stand. Since there are just two partners whatever the profits is, we divide it into two. Now after a year you go abroad, and I continue to manage the business. After several years our business starts to grow. People like our barbecue so much that they ask us to put up barbecue stands in 5 different locations. It sounds great except for the fact that we do not have additional cash to buy more barbecue stands and other supplies to put up 5 barbecue stands. In order that this plan could push through, we definitely need more cash for expansion. I go to the bank and the bank refuses me a loan. What should I do to raise more cash?

I tried to contact you, but you couldn’t be reached in anyway (Perhaps you forgot to pay your telephone and internet bills)

Well, there’s one thing I can do, I can take in another business partner and ask him to invest his money so that we can put up more barbecue stands. This sounds great. But the problem now is that in any profits that we have, we divide it into three, instead of two. In other words instead of getting a bigger slice of the pie, the original owners gets a smaller piece because another person has come in to grab the third slice. Although the pie has become bigger if only both us, has come up with the cash, we didn’t have to invite a third person to grab the third slice.

When you arrive you get mad at me because your piece of the pie got smaller. You told me that you could have financed the capital needed to fund the expansion of 5 barbecue stands. There could have been no need for me to get a third partner. In a sense you were deprived of the “potential” profit that could have been yours if you were the one who funded the capital expansion. To make matters worst, you argue that we will have to contend with the “vote” of the third investor when it comes to deciding things.

Now this may be a far out illustration but more or less, this is what a “pre-emptive right” or a “stock offering” is all about. A stock offering gives the existing stock holders the opportunity to invest in the company before such opportunity is offered to somebody else in order that the existing stock holders may not be deprived of the potential profit or growth that the business may bring.

Another benefit of a stock offering is it allows existing stock holders to maintain a proportionate ownership of the company. Maintaining a proportionate ownership in the company is crucial especially in terms of maintaining control. More can be said about this in later post.

The next question would be, how could you the existing stock holder of a company make money from a stock offering?

Aside from giving the existing stock holder the advantage of having the option to “buy-in” into the business first before the opportunity is offered to others, usually the price in the stock offering is much lower than the market price. In other words the stock holders usually get a cheaper price than those who are non-stock holders. Now of course you know what this means for you as a stock holder. Since you got the stock at a price cheaper price than the market price then more or less you would profit more once the value of the stock has appreciated.

More could be said about stock offering rights, but for the mean time we are discussing this in relation as to how this could help you make money in the stock market. Stay tuned for “How you can make money through stock market investing - Part 4”

Hi ! my name is  Zigfred Diaz, Thanks for visiting my blog where you can learn stock market investing the Warren Buffett way and using other value investing methods ! Never miss a post from this blog. Subscribe to my full feeds for free. Click here to subscribe to D’Intelligent Investor by Email

6 Responses to “How you can make money through stock market investing – Part 3”