Friday, November 18, 2011

Bear markets makes clear purpose of stock exchange

In a bear market, the reason why a company sells stock to the public becomes clear: to raise capital by all means necessary. One way has been to sell stocks in a company that does not have the money there and then runaway after you have been found out. The S-Chips are most guilty of doing that, as the down turn called their bluff. Fortunately for them, Singaporean investors go in with their eyes open and hence not very well protected.

Another way is to issue a rights issue. This has happened to myself a few times this year. Companies that already have billions of shares floating and trading in the pennies, have asked for more cash by issuing more stock. Some like GMG Global have a better story. Others like Stratech are tapping shareholders for more liquidity. The end results is likely the same: once too much shares have been issued, they are consolidated.

The final way is to take the company out of the stock exchange. Consider for a moment, when a company lists itself on the exchange, what is it really selling? A shareholder who owns 10% of all outstanding shares does not get all the earnings of the company, but dividends which are a smaller fraction of that amount. Thus, an IPO makes the existing shareholders very rich on paper, and they can realize it by selling in the open market bit by bit. Then in a bear market when valuations are depressed, they can take them private by claiming that they are unloved. Usually, a company that is making very good gets taken public this way. And if things do not work out possibly in the future, take them public again!

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