General Stock Investment Strategies/stocks

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QUESTION: What effect does the trading price on stocks do for or affect the company? My thoughts are that a company sells X number shares of stock and the price fluctuation after that is just between buyers selling between each other or are companies always selling more of their own stock therefore when price is down they get less.

ANSWER: That's a good question. The price fluctuation of a company's stock after a public offering can have some real effects on the company, even if it doesn't plan to offer more shares. Here are a few examples:

1. Compensation paid to employees can be in the form of stock and stock options. That has more value if the price goes up.

2. The share price, times shares outstanding, is the current market value of the company. If that value gets too low, it can attract attention from acquirers or others looking to "take the company private." If the share price is higher, that isn't as feasible because an acquirer needs to pay a premium usually. Dell might be an example of this at the moment.

3. On the flip side, a high stock price can let a company use its stock to acquire other companies in stock-for-stock acquisitions. The stock is basically the currency used to do the deal, so the more valuable it is, the cheaper the deal is to pull off.

4. It's obscure but debt covenants and similar things can be tied to a company's share price. If the price falls below some level, it triggers something - that's the basic idea.

5. Fundamentally, the share price is used to grade the performance of management so there is a built-in incentive to keep it up. When the price goes down, investors can put the heat on management - activist hedge funds are a current example, but it's always been the case. I don't think this is a good thing, it results in a focus on short-term performance - but it is a reality.

Those are just some examples of indirect ways that price can have an impact. Hope that's helpful.

-Tad




---------- FOLLOW-UP ----------

QUESTION: I never realized points like these but for the most part the highs and lows really does not affect the profit margin however the profit margin will affect the price fluctuation.
In dividend paying companies this fluctuation shouldn't have any bearing on the dividend or would it? .
Am I correct in this points?

Answer
Sorry, hadn't seen that you posted a follow-up (a long time ago).

An obscure case where stock price affects profit margins has to do with equity compensation for employees and the tax costs to the employer that result. But generally no, they're not really connected. As for effects on a dividend, a company might rationally devote excess cash to buy-backs if the stock price was low, rather than increasing the dividend. In practice that probably doesn't happen much, in part because low stock prices usually come at a time that a company lacks the cash to do buy-backs. Also, companies in general have a poor track record with buy-backs, often buying when the stock is high.

-Tad

General Stock Investment Strategies

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Tad Borek

Expertise

I am a San Francisco-based investment adviser and attorney.

Experience

I opened my investment advisory practice, Borek Financial Management, in 1999, and have been a licensed attorney since 1993.

I received my B.S from Cornell University, and a J.D. from George Washington University Law School.

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