When Stock Investors Get it Wrong

When you buy shares of a company, you’re getting an ownership slice. If the company does well, your shares should rise. The company may even pay a dividend, providing you with cash you didn’t have to labor over for a living.

Sounds great! But, a company is more than just the sum of its shares. Companies have a capital structure, which includes a mix of stocks (called equity), and other types of financing, typically debt.

Nearly all companies have debt. Some debt, relative to the stock value, is fine. It’s a lot like the mortgage on your home—borrowed money that lets the company do things today it otherwise couldn’t afford to do.

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  • But sometimes, companies get too much debt for their cash flows. Or they structure their debt differently than a mortgage. For instance, some debt may be convertible to stock at the right price. If it does convert, the company has less debt, but existing shareholders end up getting diluted.

    That’s part of the problem going on right now with Tesla Motors (TSLA). Shareholders may have seen their shares beat the pants off the market the past few years, but the company also loaded up on debt to finance its famous electric cars. Some of that debt came due, and, because of where the share price was at, ended up getting converted.

    The timing is pretty bad. Besides the heavy debt load and now dropping share price, the company has some big production problems and a larger-than-life CEO distracted with a myriad of other activities. When shareholders ignore a company’s debt—and when it comes due—they set themselves up for losses. It’s no wonder that Tesla shares are down by nearly half in less than a year—and why some analysts are already calling for a further 90-95 percent drop from here.

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