Will the stock price rise or fall after a cash capital increase? The disadvantages of cash capital increase that investors must understand

Many investors see a listed company’s announcement of a cash capital increase and their first reaction is to guess whether the stock price will rise. However, in reality, the impact of cash capital increases on stock prices is far more complex than imagined. Instead of blindly guessing, it’s better to first understand the logic behind how cash capital increases work and their potential risks.

What is a cash capital increase? Why do companies do it?

A cash capital increase is a method by which a company issues new shares to existing shareholders to raise funds. Companies typically take this action when they need to expand their business, invest in new projects, repay debt, or improve their capital structure.

The entire process includes: the company setting a target amount for the capital increase → sending a notice to shareholders (informing about the share price and number of shares) → shareholders deciding whether to participate and making payments → the company calculating the total capital increase and issuing new shares → increase in registered capital and change in shareholders’ ownership proportions.

Does a cash capital increase really lead to a stock price increase? Let’s look at real cases

Tesla Case (2020)

In 2020, Tesla announced the issuance of new shares worth $2.75 billion, priced at $767 per share. The purpose was to promote global expansion and new factory construction.

Generally, issuing new shares dilutes existing shareholders’ equity, and the stock price should fall. But the actual result was the opposite—Tesla’s stock price rose after the announcement. The reason is that at that time, the market was very confident in Tesla, and investors believed that this capital could help the company capture a larger market share and increase enterprise value, so the stock price actually went up.

TSMC Case (December 2021)

At the end of 2021, TSMC announced a cash capital increase, and the stock price also rose after the news was announced. As a leading semiconductor foundry, TSMC’s operational performance was stable, and existing shareholders were willing to participate to maintain their ownership ratio. The market was optimistic about TSMC using the funds for R&D, expanding factories, and investing in new technologies, which supported the stock price.

What do these two cases tell us?

The rise or fall of stock prices after a cash capital increase depends on how the market perceives what the company will do with the funds. If investors believe the capital increase can enhance the company’s competitiveness and future profitability, the stock price may rise; otherwise, it may fall.

Three mechanisms by which cash capital increases affect stock prices

Supply side: Increase in new stock supply

Issuing new shares means more stocks are available in the market. If demand is insufficient, excess supply can put downward pressure on the stock price.

Market expectation side: Changes in investor confidence

This is the most critical factor. If investors worry that the capital increase will dilute their interests or drag down future profits, the stock price may decline; conversely, if they believe the capital increase brings new opportunities, the stock price may rise.

Ownership structure side: Changes in existing shareholders’ ownership ratios

Shareholders participating in the capital increase can maintain their original ownership proportion, while non-participating shareholders’ interests are diluted. This structural change can also influence stock price performance.

Situations where a cash capital increase may lead to a decline in stock price

1. Excess supply depresses stock price: The volume of new shares issued exceeds market demand, causing downward pressure.

2. Lack of investor confidence: Market skepticism about the capital increase plan, concerns over poor fund utilization or too low issuance price, can lead to a decline in stock price.

3. Dilution of shareholder equity: Shareholders who do not participate see their ownership decrease, which may trigger selling waves and further depress the stock price.

Situations where a cash capital increase may boost stock price

1. Strong market demand: The new shares are highly sought after, and strong demand supports the stock price rising.

2. Positive outlook for the capital increase plan: Investors believe the funds will generate good returns and support company development, providing stock price support.

3. Active participation of shareholders: Existing shareholders strongly support the capital increase and buy new shares to maintain their ownership ratio. This positive signal helps stabilize and boost the stock price.

Understanding the drawbacks of cash capital increases and investing rationally

Many investors only look at the surface meaning of a cash capital increase and ignore the risks involved. Here are the disadvantages of cash capital increases that must be carefully considered:

Dilution of shareholder equity

This is the most direct disadvantage. Shareholders who do not participate in the capital increase will see their ownership proportion decrease, and earnings per share will be diluted accordingly. Especially when the issuance price is below the market price, this negative impact becomes more apparent.

Market reaction uncertainty

After the announcement, the market may be optimistic or pessimistic. This uncertainty means the stock price could decline, especially if investors lack confidence in the company’s prospects or fund utilization plans.

Increased financing costs

Cash capital increases involve paying fees, issuance costs, and other expenses. Moreover, if the issuance price is below the market price, it is akin to the company selling stocks at a discount, indirectly reducing enterprise value.

Short-term stock price pressure

The increase in new stock supply can cause short-term downward pressure on the stock price. Coupled with market sentiment volatility, the stock may face risks of decline.

When can investors receive the new shares after a cash capital increase?

After participating in a capital increase, investors need to go through several steps to receive the new shares:

Capital increase deadline: Investors must pay before the deadline set by the company, which then performs the accounting.

Exchange approval: The company’s new share issuance requires approval from the stock exchange, which takes time.

Shareholder registration: The company must complete shareholder registration procedures before officially issuing new shares.

Therefore, from participation to receipt of new shares, it usually takes several weeks to months. During this period, investors should continue to monitor the company’s progress and make judgments based on the latest fundamentals and market trends.

Investment advice: look beyond cash capital increases and consider the bigger picture

A cash capital increase is just one of many factors influencing stock prices. A company’s profitability, industry outlook, market sentiment, economic cycle, and policy environment all significantly impact stock prices. Relying solely on cash capital increases to predict stock movements can easily lead to misjudgments.

Before investing, it is essential to analyze the company’s fundamentals, the specific use of the capital increase funds, market perceptions of the industry, and macroeconomic conditions to make more rational investment decisions.