Factors that May Drag a Stock Price Inspite of Fundamentals

Recently I was evaluating a stock to purchase and I discovered something that makes the stock unattractive, despite the company sporting compelling valuation and a well respected management with a track record of growth. The company had in the past issued a large number of stock warrants. Since the stock price is now touching the strike price on these warrants, the possibility of large scale exercise of the warrants is quite real. Warrant exercises are dilutive to the existing shareholders as the company needs to issue new stock. Since this company has as many warrants outstanding as the amount of common stock, the dilutive effects could be really pronounced.

In this case, I found the warrants a better buy then the common stock. It is quite instructive to see what other financial instruments can dampen the stock price appreciation.

Stock Option Awards: Companies award stock options to their employees and the management all the time. Sometimes, these awards can be large. For example, when a company hires a new star CEO, they might sweeten the pot. Unfortunately, depending on the strike price of these option awards, it can dilute the existing shareholders.

It may also be worthwhile to comb through the financials and pay some attention to the stock options issued in the past that are as yet unexercised. Investors tend to skip over this section in the filings as generally these are not too significant in comparison to the total common stock outstanding, but in some cases it may be a mistake to do so.

Covertible Debt or Preferreds: If the company has issued convertible debt or convertible preferred stock in the past, one must consider the likelihood of the conversions taking place, These conversions are generally done with new stock issue.

Existing Shelf Registration for New Stock: A company may have filed shelf registration for a secondary offering which may not have been exhausted. Sometimes this is done to re-capitalize, by using the newly raised equity to retire debt. Or the company may have acquisitions in the pipeline. Paying attention to maturing debt or the company's strategies may give an indication if there is a likelihood of new equity being raised.

Severance Pay: For a small company with a market value of less than $100 million, a severance pay of a few million dollars to an outgoing executive can be material to its future EPS. It is quite easy to overlook this factor and then get blindsided on the next earnings report.

SEC filings generally call out such possibilities so it is quite important to review the filings from cover to cover during the initial research and then periodically. For most large and mid cap companies, these are minor factors and the effects could be minimal. For smaller companies though, these can become quite critical in building your investment thesis.