Why a Secondary Stock Offering Is a Huge Buy Signal

magnifying glass stock chart

There’s a fine line between fishing and just standing on the shore like an idiot.” – Steven Wright

I grew up in Vermont, and my parents had a summer cottage on Lake Champlain.

One of the best ways to keep a group of kids out of trouble is to get them out fishing. So that’s what we did; with my parents, grandparents, and, eventually, just with the kids.

There’s a healthy population of largemouth and smallmouth bass in Lake Champlain. Some real lunkers even.

Then, and now (when I have time to take my kids fishing), one of the most memorable and exciting parts of fishing is when you see a big fish follow your lure … and absolutely inhale it.

It’s like you can see the entire aquatic environment around your bait get sucked into the fish’s mouth and disappear, as if it was never there to begin with.

When fish do this with wild bait (not a lure with a hook in it) they get stronger and have more energy to pursue life-sustaining meals.

Secondary Stock Offering: A Bullish Small-Cap Stock Buy Signal

The stock market analogy to a huge bass inhaling a meal is a well-received secondary stock offering, or a well-received convertible note offering.

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In these scenarios, a company announces it will raise capital by issuing new shares to the public (secondary stock offering) or by issuing low interest-bearing notes that can be converted into shares, usually within five to 10 years (convertible note offering).

The company completes the offering at an attractive price and the shares are quickly absorbed by the market.

In fishing terms, the market “inhales” the new shares. And the stock’s trend continues, more or less as it had been prior to the secondary offering. Management pursues growth initiatives with the new capital.

Both traders and longer-term investors view a well-received secondary stock or convertible note offering as a bullish signal. Check out this quick exchange I had with Cabot Options Trader Chief Analyst, Jacob Mintz, last week.

Jacob doesn’t do a lot of bass fishing. But he guides his subscribers into many profitable options trades on strong stocks, some of which have recently completed secondary offerings. Year to date, his portfolio is up well over 50%!

The well-received secondary stock or convertible note offering is an especially strong buy signal for certain small-cap stocks. That’s because it signals huge demand for a stock that still has a relatively small public float, as compared to larger companies.

If the market thinks a company is issuing shares to raise cash for good things, like attractive acquisitions, to fund new product development, to expand a sales team to meet demand, etc., then a stock can easily go up after the announcement.

In this bullish scenario there are many investors that are eager to buy the newly issued shares (or notes). And they get inhaled by the market.

Check out this chart of Coupa Software (COUP), a mid-cap stock with a market cap of $7.2 billion. This is the stock Jacob mentioned in our exchange.

Coupa announced a convertible note offering on June 5, pricing of the notes on June 7, and closing of the notes on June 11. Other than a bump in trading volume, there’s little in the chart that tells you the company raised capital. And certainly nothing negative. This all happened in context of the company having reported quarterly earnings just before the announcement, and a somewhat volatile market.

Bottom line: Coupa is trading higher after the announcement, as you can see below.

A secondary stock offering last week sent Coupa Software (COUP) to new highs.Granted, this was a convertible note offering and not an outright secondary stock offering, which is more dilutive. And to be fair, it’s only been about a week since the offering was announced, and a couple days since it closed.

Let’s look at another example.

The chart below is also for Coupa Software, but it’s a 30-month chart. And it shows a follow-on public offering priced at 25.25 that was announced on April 11, 2017. There were a few wobbles in the stock afterward and a long consolidation phase around 30 in the summer. But the stock price stayed above the offering price, and it’s up over 360% since.

How about a different, smaller stock?

The chart below is for Everbridge (EVBG), which currently has a market cap of $2.8 billion. Everbridge has completed three capital raises since it went public at 12 in September 2016. And it’s up roughly 600% since.

Everbridge completed a secondary offering in April 2017, a convertible note offering in November 2017, and another secondary stock offering in January 2019. All were inhaled by the market, just like a lunker bass inhaling a crayfish!

How to Find the Market’s Best Small-Cap Stocks

Too many investors think a secondary stock offering from a small- or mid-cap company is a bad thing. And in some cases they are.

There are far too many examples of small companies, especially micro-cap stocks, that issue shares of stock just to keep the lights on and meet payroll. These stocks, which are usually bad investments, usually trend down (or at best sideways) before, and after, the offering.

But don’t assume all secondary offerings are bad just because some are.

There are also many examples of small-cap stocks that complete secondary stock offerings because it is the most efficient way to raise growth-fueling capital.

A perfect example of this misconception played out a few weeks ago when a stock in my Cabot Small-Cap Confidential portfolio announced a secondary offering. I received the following email from a concerned subscriber. (Note: I’ve put blanks in place of the stock name and certain other key numbers, to protect the innocent and my own subscriber portfolio!)

“Tyler, What are your thoughts on ___ secondary offering?? Bad timing to say the least.”

My response was as follows:

“I actually have a positive take on it. I think ___ can use the capital for good, growth generating investments. And better for existing investors to issue shares at a good price than when a stock is beaten up (more $ per share = less dilutive). Also, the stock is flattish today, which tells me that demand is high (as does the chart).

“I’m not discouraged, pending a good price (yet to be announced). With ___ million shares to be offered that increases the diluted share count by only around 5%. Assuming an offer price of __ or more the offering should bring in north of $224 million.

“One of the keys here is for ___ to keep building out its _____. And that’s either labor intensive or requires acquisitions to buy specialized providers who _______________. Having cash should speed up the time to build out the _____, which, theoretically, means ___ can offer more transactions to existing and potential customers, which should bring more $$ in the door.

“So that’s the positive spin. The negative is that it’s dilutive. But again, I don’t feel it’s egregiously so.”

This is what that stock’s chart looks like. The market inhaled the secondary stock offering.

 Are all small-cap and mid-cap secondary stock and convertible note offerings well received? No.

But those that are can tip investors off that demand for the stock is high, that institutional investors are confident that the capital will fuel growth initiatives, and that the stock is a good investment.

How do you figure out which ones you should buy?

That’s the tricky part. You can follow the market closely and dig around to find out which companies are completing secondary stock offerings. Then track their stocks to see how they respond.

Or, you can follow Cabot analysts that will get you into those good stocks early, and keep you there through bullish secondary stock and convertible note offerings.

If trading options is your game, check out Jacob’s services, Cabot Options Trader and Cabot Options Trader Pro.

If you prefer a long holding period and are interested in small-cap stocks, check out my service, Cabot Small-Cap Confidential. My portfolio is up an average of 94% right now, including a better-than 60% gain in the stock discussed above, over just four months!

To learn its name, and what other small-cap stocks I’m currently recommending, click here.

Tyler Laundon

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Tyler Laundon is chief analyst of Cabot Small-Cap Confidential. The circulation of Small-Cap Confidential is strictly limited because the undiscovered stocks with sky-high-potential that Tyler recommends are often low-priced and thinly traded. Don’t share these recommendations!

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