Jogging in place waiting for the light to change, your running partner says she is thinking about participating in an upcoming right issue. “Is it good to buy right issue shares?”, you ask with passing familiarity. The light changes and she’s off and you pick up the pace to catch up to hear her answer.
Is it Good to Buy Right Issue Shares?
It may be good to buy right issue shares under certain conditions. We will look at the pros, cons, and key considerations to add context to the answer to, is it good to buy right issue shares?
Right issue shares are additional shares offered by a company to its existing shareholders at a discount. The firm issues the shares to raise capital. They are called right issue shares, or right issues because the company extends the right to purchase the discounted shares.
Shareholders are given the first right of refusal to purchase the shares prior to them being traded publicly. The number of shares offered to each shareholder is in proportion to their current shareholdings.
The purchase offer is time-sensitive and will expire worthless if not exercised. Shareholders can elect not to purchase additional shares but can trade their purchase rights in the open market. This option is called tradeable or renounceable rights.
Is it good to buy right issue shares? Let’s examine the pros:
The Pros
Below Market Price – Right issue shares can be a good investment because they are offered below the current market share price. Shareholders can easily calculate their potential profit and the lower price allows them to purchase more shares.
Dilution Avoidance – Existing shareholders can maintain their current ownership percentage and avoid dilution by participating in the right issue.
Profit Potential – The right issue discounted share price is offered at a built-in shareholder profit. If the share’s value increases, shareholders will benefit from additional capital gains.
Is it good to buy right issue shares? No investment is perfect, so here are the cons:
The Cons
Idiosyncratic Risk – Idiosyncratic risk is the risk associated with a specific company, sector, or industry. If the reason the firm is issuing the additional right shares is because of financial distress, your current and any subsequent investment may substantially decrease in value.
Non-Participatory Dilution – Nonparticipation in a right issue offering will dilute your current ownership percentage. For the average shareholder, this is inconsequential, however, very large shareholders will find reduced influence over company decisions accompanies their ownership reduction.
Market Perception – Right issue market perception can be negative and may adversely impact the company’s stock price. Plummeting share prices beget declining investment value triggering an increase in opportunity cost. The opportunity cost is the opportunity forgone because your funds are already committed to a particular investment and, in this case, a disintegrating one!
Here are the key considerations to keep in mind:
Company Motivation – Understand the firm’s motivation for the capital raise and how they plan to use the funds.
Firm Fiscal Health Assessment – Evaluate the company’s growth prospects, past and present performance, and overall financial health prior to any additional investment.
Your Investment Criterion – Are you interested in short, medium, or long-term growth or is immediate income-generation your goal? Make sure the right issue investment aligns with your strategy.
Economic Timing – Assess the macroeconomic climate and systemic risk of the right issue. Avoid the loss of permanent capital at all costs.
Right issues can be good investments provided certain conditions exist and they’re entered into after a thoroughly researched and analyzed risk/reward profile.
Read next: Can I Sell My Rights Issue?
