An option gives us the right to convert into shares. So, why don’t we always exercise that right? Say we owned Tesla options. Who doesn’t want shares of Tesla? Well, like everything in finance. It depends on the price. If the price is not right, it may not make sense to exercise the option. By exercise, we mean take the
Do we care about basic or diluted shares in M&A? In M&A, the acquirer (buyer) is attempting to buyout the target (seller). In order for the buyer to purchase each outstanding share in the selling company. So, if the target has 100 shares, the buyer would need to buyout the entire 100 shares to acquire 100% of the company. But,
What makes purchase equity value different from equity value? Equity value is also known as market capitalization. It is share prices x shares outstanding. Purchase equity value is different from that. It has to do with the value that is attributed to equity investors in a case where the company was being acquired. The acquirer will offer to purchase the
Why would shares slide on the announcement of an M&A deal? Maybe, the deal is dilutive. What do we mean by dilutive? It means that whatever metric we use to benchmark the deal performance is falling after the transaction occurs. The metric we often use in M&A is EPS so see the short-term implications of the transaction. So, if the
In business, there is a tradeoff between focusing on short-term and long-term financial performance. Companies can choose to generate short-term cash flows. How so? Sell what sticks today. Sell high margin products. Cut back on operating expenses. Reduce capital expenditures. This helps (i) expand margins and (ii) increase free cash flow generated. But a sole focus on generating high-levels of
Diluted equity value. A pizza party with all your uninvited neighbors. Dilution. It seems bad. But, what does it really mean for shareholders? Dilution means that more people are involved, so you get less value. Say I have a pizza party. I would want the fewest number of people showing up. Why? Because I want the most pizza to eat.
We often hear that EPS captures all the effects of a transaction. What does this really mean? Well, it refers to the fact that EPS captures the full cost of capital. It does so in a way that other income statement metrics wouldn’t like net income, EBIT, EBITDA, gross profits, or revenue. What do we mean by cost of capital?
Why do we divide earnings by the number of shares outstanding? We know that we cannot compare earnings of one company to another because that does not tell us how cheap or expensive a company is. Just because DropoutEdu has $100M in net income and UnlearnEdu has $50M in net income, we cannot conclude that UnlearnEdu is cheaper. It could
Why do journalists and investors use earnings per share? It tells us the amount of earnings a company generates. But, why don’t we just look at net income. Why create a new line that companies must report under GAAP accounting. There is a mathematical difference between net income and EPS. Take this example. DropoutEdu earns $100 million a year. UnlearnEdu
Share count is completely arbitrary. Just because a company has more shares than another, does not mean it is bigger. Just because a company has fewer shares than another, does not mean it is smaller. Why? Because the value of equity of a company is a function of two things. (i) Share price (ii) Shares outstanding Just because there are
