OTC dilution vs big board old post when I use to teach.
Lately the board has become more about stock picking then education. I've received several private questions about sub penny trading action & share dumping.
I would like these types of questions to be brought to the board. That way by answering questions, more then one person can learn.
I'd like to spend a little time tonight covering a subject I feel needs repeating. The use of big board terms on OTC stock message boards. Specifically Dilution. By understanding the different reasons for a company to delude their stock. Maybe you can focus on trading, more then message board hype.
Dilution is when a company increases the shares outstanding! The reason this is done is for the company to raise capital. You see the markets you trade and profits & losses seen in those markets are not seen by the companies, but the shareholders which own the common stock.
If a company is not profitable or just needs cash to implement a business plan, to become more profitable, they may need to sell common shares from time to time.
Funding public companies can take many directions with big board companies. They can sell common, sell assets, sell restricted shares (preferred stock), or go to banks, private equity companies, or other large investors for loans. These loans, as with all loans, need something backing them to reduce the risk of loss.
Dilution occurs when common shares are taken from, the companies AS (authorized shares) and moved to their OS (outstanding shares).
You may hear of, or see the term fully deluded shares in a Quarterly, annual report, or news release. This is the worst-case scenario for the EPS (earnings per share) metric, including OS (outstanding shares) plus all options (contracts to sell common) warrants (guarantees to sell common) and restricted (common that can't be traded until released by contract) & preferred (unregistered common shares).
Increasing outstanding shares, increases the EPS denominator while the numerator (earnings) remains the same. The result of dilution decreases the EPS. Thus increasing the PE ratio (profits/earnings).
This one fact is where shareholders perceive loss in value. Actually by raising cash the companies future is probably increased in value, because it now has the cash needed to begin to activate the business plan, to increase profits. And actually the value of the company has NOT changed, only two ratios used by retail to evaluate value has changed! Book value, profit margins, EBITDA, Revs, ETC still maintains the same value for the company over all.
Within this behavioral finance perception lies the catch 22. Is it better for the shareholder for the company to delude the stock, by raising capital, lowering short term EPS, or stay stagnate without hope of increasing earnings, to increase the EPS in the future?
This is where past performance comes into the due diligence investors need to do. Can investors expect management to succeed with it's business plan?
If management is a good one, with a history of successful financial results. Then dilution should be considered good for shareholders, if management has not preformed well, then dilution should be considered bad.
Any time dilution takes place with a company which does not have profits (a positive EPS, thus a in-line sector PE ratio) investors need to believe (Trust) completely on speculation, that management & the company business plan will produce the results wanted.
Here we are in pennyland, the OTC. With big board companies you can evaluate the financial history. With OTC companies this evaluation usually does not include the financial indicators needed to evaluate managements ability.
Also because of this lack of reasonable historical financial data OTC company funding takes a different track form big board companies.
OTC companies raise capital by obtaining share backed loans from VCs (Venture Capitalist), large private investors, or sometimes M&Ms (Market Makers), needing to create an inventory of stock, to make market for the company stock.
OTC funding deals often include several types of share transactions within a single deal, to secure funding capital. Including out right issuing of common, with warrants and/or restricted preferred.
This is where the fully deluded share structure really come to play. Because unlike a big board company, the only thing backing the loan is stock. The company assets or historical performance does not exist. So big guy OTC funders need to know up front, they will turn a quick ROI (return on investment). With possible future stock gains to lower longer term risk.
From this fact comes the pump & dump! The run/retrace/channel setup seen in the PR story pop & then blitz!
My theory is in pennyland you will read about company restructuring, see a PR & small price pop. Then funding news. followed by a PR story blitz, funding deal and price run.
The pop is proof to the VC the company can sell the story. Once VCs get stock, the (OTC business plan) the sell stock story is implemented. Also note the pump is the story, the dump is the selling into the run. NOT the retrace after!!
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I will end this with this; Companies do NOT sell stock directly into the open market, to delude shareholders. As you read on every pennyland message board!!! They sell stock to large investors in large blocks. The dilution takes place the second common is issued, not when the issued stock is traded in the OTC market.
So you can forget all the hype about the company is deluding, by dumping common at or below bid. Big guys don't dump lower. they sell higher!! And these big guys are VCs which profit in one way. Selling shares to emotional retail!!!!! In runs created to do so.
Understanding and trading this is where money is made. Not by holding long & strong!! Never believe the PR story, trade the retail reactions to it!
