Most investors would know that just because a listed company’s share price changes daily, it doesn’t mean that anything fundamental has necessarily changed on that particular day.
Listed companies originally receive funds when they sell shares through an Initial Public Offering (IPO). It is within the secondary market on the stock exchange where the share price is determined by the interest between the buyer and sellers. However, even though a company does not directly lose money when their share price drops there are implications to a company with a falling share price.
Financing
A company’s stock can be used to purchase other companies. When a stock price falls then the company must sell more shares of stock to raise the same amount of proceeds. If the stock price falls too much then the company may need to borrow money to raise funds to expand the business.
The share price can also impact financing from banks. This is because they see a link between a company’s earnings and its share price. Creditors will be more receptive to companies with stronger share prices and offer them a lower interest rate. They will see companies with strong earnings in being in a better position to repay debt long term.
Raising Capital
If a Company’ share price has been falling and then they want to raise capital through a share rights issue then they may find it difficult to find shareholders who want to participate. Shareholders may not have confidence in long term prospects of a company with declining stock prices.
Management
If the stock price performs badly for a prolonged period of time, shareholders may become frustrated and look for changes to be made in the management team. Shareholders are part owners of the company so they can vote out board members if they are unhappy.
The company’s management team or founder may own a substantial number of shares. If the share price falls then this would affect their personal net worth. Employees of the company may receive bonuses in the form of shares so if the share price falls the value of their bonuses falls as well.
Fundamentals
Share prices can be used as a gauge on the financial health of the company. Analyst examine company earnings and the stock price to determine their opinion. There are many financial ratios these analysts use which have the stock price in the calculation. Stock prices can display the outlook of the company by market participants.
Takeover Threat
Companies which have low share prices are susceptible to take overs. Shareholders will continue to be unhappy if a company continues to have low share price. If a rival proposes a takeover bid, then shareholders may take up the offer if they no longer have confidence with the company.
Public Perception
A falling share price may give consumers a negative view of a company. Consumers may hesitate about purchasing goods from a company they think may dissolve. This may trigger concerns about how they are going to obtain spare parts or product support for repairs of their goods in the future.
Less Investment
A declining stock price can also lead to less spending on investment for a company. Company executives become more conservative about expansion when the share price is not doing well.
Lauren Hua is a private client adviser at Fairmont Equities.
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