Imagine a company is like an enormous pizza, and each shareholder can get only one slice. Would you rather have a smaller slice or a bigger slice? What if you buy a slice of the pizza, but then the company takes part of everyone's slices back to make more slices?
The actions of company management and company boards should be watched carefully, particularly with regards to the number of shares outstanding, The number of shares outstanding and circulating is like currency. Shareholders and analysts should be watching to see if the number is increasing or decreasing.
Increasing the number of shares (all other things being equal) could mean that the shareholders are being diluted. On the contrary, decreasing the number of shares could mean that the shareholders are being concentrated. Though in general, dilution is bad while concentration is good, things are rarely that simple. Investors need to understand why dilution is taking place. For example, the company could be raising money to invest in growth, which will be a good thing in the long term.
Fortunately, GuruFocus makes it easy to see if shareholders are being diluted or concentrated. For example, here is a chart of Moderna Inc. (MRNA, Financial) which shows the number of shares outstanding. As we can see, the number of shares is rising. This means that the company is creating more shares and is thus diluting existing shareholders. The dilution trendline is about 10% per annum.
Given Modena is a young company experiencing high growth, it makes sense that it would raise money to invest in growth projects. Selling high priced shares in the market may be better than raising money via debt. Regardless, this investment is costing the shareholders money by diluting them at the rate of 10% a year. If a company is diluting shareholders but does not have a good reason to do so, investors may be better off staying away from that company.
It's also possible the company may be in distress and using the market as an ATM to stay alive, or perhaps the new shares are due to overzealous stock option compensation plans for executives. I don't think such a worry exists for Moderna, but these problems do show up with some companies.
Now look at Pfizer Inc. (PFE, Financial), which is doing the opposite of Moderna. It is buying back shares, thus concentrating the shareholders.
When a company like Pfizer buys shares, it is in effect returning money to shareholders by concentrating their owneship. The rate of decline of shares outstanding over the past five years is about 1.7%, which is an estimate of the benefit the shareholders are getting each year. Pfizer also pays dividends (~3%), so shareholders are getting a double benefit, dividends and buybacks. Both are good things, right? Pfizer's board deserves a round of applause in my view.
Takeaway
Investors all too often ignore the shares outsanding, but this is one metric that we should all be watching like a hawk. Understanding changes in shares outstanding, as well as the various reasons why a company is buying back shares or issuing new shares, is essential to determining whether a company's management is shareholder-friendly.
