When a Drop in Share Price is a Good Thing

Dividend Investing, Real Estate Investment Trusts (REITs)
Growing plants on rows of coins.

Dear Reader,

Last week, one of my recommended stocks, Starwood Property Trust (STWD), announced a $400 million secondary offering of common stock. The new shares will go to institutional investors and typically get priced at a discount to where the stock currently trades.

As a result, the STWD share price dropped 3.5% the day after the secondary stock sale.

Now, when a company sells more shares of its stock, the overall share price always drops. When one of the recommendations from The Dividend Hunter comes to market with a secondary offering, members send me emails asking whether the share sale is a good or bad thing for our holdings.

As with all things stock related, the answer is: it depends…

Starwood is structured as a real estate investment trust (REIT) and provides an excellent example of why additional shares get offered. A REIT is required to pay out at least 90% of net income to investors as dividends. That requirement does not leave much money in the company to fund growth.

Because of the 90% rule, any growing REIT will have to tap equity markets (i.e., the stock market) to acquire growth capital.

As an investor, when you see a share price drop from a secondary stock offering, your question should be whether the company will put that new capital to good and profitable use.

A company raises money by selling shares for one of two reasons. Possible reason one: the company is not making enough money, and it needs the cash to try to have some investment capital on hand to get back on track. Possible reason two: The company is very successful with its business, and with more equity capital, additional smart investments can be made to continue to increase profits.

So, with a share price drop due to a secondary stock offering, the secondary will be a great time to pick up some shares “on sale” for a reason two company. But for a reason one company, the share discount is not a bargain. It is unlikely that a bad business will make a turn for the better with an infusion of cash.

Bottom line, when you see a stock price drop due to a secondary stock offering, it may be time to buy. Just make sure you understand the company’s business and how they would use the money to benefit shareholders. Starwood Property Trust is a great company, and last week was a good time to pick up some shares.If you like high-yield investments, my Dividend Hunter service helps subscribers navigate the effects of corporate actions such as Starwood’s secondary stock offering. Click here to learn more.