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Companies and Their Stock Prices

Q: Do companies want their stock prices to be high? — B.H., Dothan, Alabama

A: In general, yes. But understand that when people buy shares of a company’s stock, those proceeds go to whoever sold the shares, not to the company.

Companies collect their money when their shares are first issued — via an “initial public offering” (IPO). Those shares then trade between investors in the stock market. When you buy shares of, say, Hershey through your brokerage, you’re buying from an investor who wants to sell. (Think of baseball cards: The companies printing them are paid when the cards are first sold; after that they’re traded between owners, with their value rising or falling.)

If Hershey’s stock price falls significantly, so will its market value, and a competitor might try to buy it. Also, low stock prices limit a company’s flexibility. When Hershey’s stock price is high, if it tries to buy another company with its stock, the acquisition will require fewer shares. And if Hershey wants to raise cash by issuing more shares, it will get more for each share when the price is high.

Q: What are “diluted” shares? — F.M., Carson City, Nevada

A: On an income statement, you’ll see a company’s bottom-line profit, or “net income,” divided by total share count to arrive at earnings per share (EPS). The EPS is sometimes reported in two ways: “basic” and “diluted.” Basic EPS uses the number of shares that currently exist, while diluted EPS includes shares that could possibly exist, such as if people with stock options exercised them. Other securities that could be converted into common stock are also accounted for. Focus on diluted, not basic, numbers.

EDITOR’S NOTE: The Motley Fool is an investment column created by brothers David and Tom Gardner and distributed by Andrews McMeel Syndication.