A Lesson In Dilution

Many people fail to realize the permanent impairment that occurred for many equity investors in 2009.  While some stocks look cheap on the surface, as measured by their stock price, and their historical highs and lows, many uneducated investors, and sadly even smart people miss the powerful impact that dilution has on shareholder value.

Using Citigroup as our guinea pig, take the two charts below.  The first is a historical price chart of C.  The latter is a historical market capitalization chart of C.  The first is more common, and a simple way to follow the price history of Citigroup stock.  What is often left out of people’s minds, is what the stock price represents.  Taken alone, a stock’s price means almost nothing.  What is also important to know is the number of shares outstanding and the underlying value you own in the company.  This is intuitive when stocks split, or reverse split and the investor sees dollar for dollar and share for share how the price and shares traded change.  In these circumstances you still effectively own the same percentage of the company.   Common examples of splits are when the price doubles and the number of shares outstanding halves, or  when the number of shares double and the price halves.

What happened in 2009, however, was not simply a splitting of shares and prices.  What happened to many companies in dire need of raising capital is that they sold equity at very depressed prices.  This means that existing shareholders held the same amount of shares, but that they lost part of their percentage ownership when new investors were allowed to buy the company for less than they paid for it. What does this mean?  Well simply put, Citigroup stock was one of many, but possibly the best example of the Great Dilution of 2009.  At its height in December 2006, Citigroup stock traded as high as the mid $50’s with a market capitalization at that time of about $270 billion.  Today, Citigroup trades just above $4 with a market capitalization of about $120 billion.  Thus in order for Citigroup to trade at a level that would make it worth as much as it was worth at the top of the last bull market, the stock would have to rise only to $9.50.  If Citigroup were to rise back to the mid $50’s, the company would then have a market cap of approximately $1.5 trillion.  Said another way, this ain’t gonna happen anytime soon, or ever (in at least the next 20 years).  Of course stock buybacks would reverse the effect of the dilution, but one would have to presuppose that Citigroup is in a position to post outsized profits for a very long period of time with enough free cash flow, in excess of reinstating a dividend to buy back shares, highly unlikely.

Citigroup Price Chart

Citigroup Market Cap Chart

Charts courtesy of http://ycharts.com/

Citigroup is one of many examples, but the size of the dilution created by the capital raises and government bailout/ownership/exit makes it a prime example.  Anyone who thinks stocks like Citi look cheap today, ask yourself this: Do you think Citigroup can appreciate to a level where its value becomes greater than twice today’s value of Bank of America, Goldman Sachs, JP Morgan, Wells Fargo and HSBC combined?  If you think that is possible, please email me as I have a bridge that you might love to own.


One Response to A Lesson In Dilution

  1. You make a very good point. While we focus on share price this means little following a dilution. A companies market cap should be more readily available. Indeed, a five year graph of most companies share price doesn’t mean an awful lot.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s

%d bloggers like this: