Latest / How Canadian Markets Work / Episode 66: Rights vs Warrants vs Options (The Dilution Distinction)

Transcript

Episode 66: Rights vs Warrants vs Options (The Dilution Distinction) · How Canadian Markets Work

0:00
Imagine you own shares in a company. Let's say
0:03
you've got a nice clean 10 % slice of the corporate
0:06
pie. You did your homework, you read the earnings
0:09
reports you bought in, and you're holding on
0:11
for the long haul. You haven't sold a single
0:14
share. The broader market hasn't panicked, the
0:17
company hasn't even reported any bad news, yet
0:20
somehow you wake up one morning, check your portfolio,
0:24
and your 10 % slice of that pie just shrank to
0:27
9%. Yeah, which is just the worst feeling. Your
0:30
piece of the company is literally smaller. Why?
0:35
Because someone else, somewhere, pushed a button.
0:37
It's an incredibly frustrating scenario for any
0:40
investor. And the wild part is that, you know,
0:42
it happens every single day across the market.
0:44
Totally. We like to think of our ownership in
0:46
a business as static. You figure, well, if I
0:49
don't sell my shares, my stake in the ground
0:50
doesn't move. But the reality of modern financial
0:53
markets is it's much more fluid. Right. And honestly,
0:56
a lot more heavily engineered behind the scenes
0:58
than most people realize. Which perfectly sets
1:01
up our mission for today's deep dive. We're getting
1:03
into what we're calling. the dilution distinction.
1:06
I like that name. Thanks. So today we are unpacking
1:10
three financial instruments that sound incredibly
1:13
similar on paper. If you follow the markets,
1:16
you see these terms constantly, right? Rights,
1:19
warrants, and options. Exactly. At a fundamental
1:21
level, they all do the exact same thing. They
1:24
give someone the right to buy shares of a stock
1:26
at a set price. But here is where it gets really
1:29
interesting. Yeah. While two of them secretly
1:32
shrink your ownership percentage, which is what
1:35
we call dilution. The third one doesn't affect
1:37
you at all. And for you, the learner trying to
1:40
navigate your own portfolio, these terms just
1:42
get thrown around interchangeably by the financial
1:44
press all the time. Oh, absolutely. You read
1:46
an article that says a company has a massive
1:48
amount of options or warrants outstanding, and
1:50
it's just so easy to glaze over it as dense financial
1:54
jargon. Yeah, you just kind of skip to the next
1:56
paragraph. Right. But we aren't just going to
1:58
read off textbook definitions today. We are going
2:01
to look at the exact mechanics of how the money
2:04
and the shares actually move. Because if you're
2:06
going to put your hard -earned cash into a company,
2:09
you really need to know how to spot these hidden
2:12
claims before they start shrinking your slice
2:15
of the pie. Exactly. So to figure out why your
2:18
slice shrank in the first place, we have to trace
2:21
the shares back to the source. Right. We can't
2:24
just look at the person buying the shares. We
2:26
had to look at who actually hit the print button
2:28
on those new shares. The identity of the issuer
2:31
is the single distinction that determines who
2:34
bears the cost when these instruments are used.
2:36
It dictates everything about where the money
2:38
flows. So think about this like concert tickets.
2:41
Let's say you have a ticket to a sold out stadium
2:43
show. You're inside. You're enjoying the music.
2:46
Sounds great. Now out in the parking lot, a fan
2:49
decides to sell their ticket to another fan who
2:51
really wants to get in. When that transaction
2:54
happens, the stadium itself doesn't get any bigger,
2:57
right? No, of course not. And the band doesn't
3:00
get any more money. The total number of people
3:03
allowed inside the venue stays exactly the same.
3:06
It's just a different person is sitting in seat
3:08
4B. Right. But what if the venue management secretly
3:11
prints a thousand more tickets at the back door
3:14
and just, I don't know, sells them for half price?
3:17
Well, then you've got a problem. Yeah. Suddenly
3:19
the general admission floor is packed, you can't
3:21
even see the stage, and your entire experience
3:24
is diluted because the space is overflowing.
3:27
That analogy maps perfectly to the financial
3:29
plumbing we're talking about here. Let's draw
3:31
the absolute line between these instruments right
3:33
now using your stadium. OK, let's do it. That
3:36
first scenario, fans, trading tickets in the
3:39
parking lot, that is an exchange traded option.
3:42
An option is a contract created strictly between
3:45
two market participants. The company whose stock
3:48
is being traded is merely the subject of the
3:50
contract. They aren't a party to it. Meaning
3:53
the company itself has absolutely nothing to
3:55
do with the fact that this contract was even
3:58
written. It's not a thing. If I own a hundred
4:00
shares of a tech company and I sell you a call
4:03
option giving you the right to buy my shares
4:05
at a specific price, that agreement lives strictly
4:08
between you and me. Just two fans in the parking
4:10
lot. Exactly. The clearing house facilitates
4:13
it, but the company is completely oblivious.
4:16
If the stock goes up, and you exercise that option,
4:20
I am legally obligated to hand my existing shares
4:23
over to you. Right. The company creates no new
4:26
shares to make this happen. They receive zero
4:28
cash from your purchase. The total share count
4:31
in the market stays exactly the same. So no other
4:33
shareholder is affected. Consequently, no other
4:36
shareholder in that company is diluted by our
4:39
transaction. It's just a transfer of existing
4:41
shares. Someone else takes seat 4B, but the stadium
4:44
capacity hasn't changed. But now look at rights
4:47
and These are the tickets being printed at the
4:49
back door of the venue. Uh -oh. Yeah. Both rights
4:52
and warrants are issued directly by the company
4:54
itself. They don't originate on an exchange between
4:58
two random traders. So when an investor holds
5:01
a warrant and decides it's time to exercise it,
5:04
they aren't buying shares from another investor
5:06
in the secondary market. The company literally
5:09
creates brand new shares out of thin air. Wow.
5:12
And then they hand them directly to the warrant
5:14
holder and absorb their cash. So the total share
5:17
count physically rises? Yes, it does. And if
5:20
the total number of shares in existence goes
5:22
up, but my personal number of shares in my brokerage
5:25
account stays exactly the same? Then your percentage
5:28
of the overall company just drop? I'm diluted.
5:31
You are diluted. And that is the absolute baseline
5:34
takeaway you need to lock in today. If a massive
5:37
hedge fund exercises a million exchange traded
5:39
call options on a company you own, nothing happens
5:42
to your ownership stake. Because the total share
5:45
count didn't change. Right. But if they exercise
5:47
a million company issued rights or warrants,
5:49
your ownership percentage just dropped and your
5:51
shares are mathematically worth less. Wait, wait,
5:54
hold on. Let me push back on that for a second.
5:55
Yeah. Let's think about the actual mechanics
5:57
of that. If the company is issuing these brand
6:00
new shares, They're collecting cash for them,
6:03
right? The warrant holder can't just get the
6:05
shares for free. No, they have to pay the exercise
6:07
price. Right. So yes, the total share count goes
6:09
up. But the company now has millions of dollars
6:13
of fresh cash sitting in their bank account.
6:15
Their enterprise value just went up. Shouldn't
6:18
that completely balance out the fact that there
6:21
are more shares? I mean, why is this automatically
6:23
a bad deal for my portfolio? It's a completely
6:26
logical question, and honestly, it's the hurdle
6:29
most retail investors trip over. It really feels
6:32
like it should balance out. The company got cash.
6:35
Yeah, more cash is good. But the problem lies
6:37
entirely in the price at which those new shares
6:40
are being sold. Let's walk through a precise
6:43
math example straight from the source material
6:45
to show why it absolutely does not balance out.
6:48
Walk me through it. Let's hear the math. Imagine
6:50
you own shares in a manufacturing company. Currently,
6:54
this company has 10 million shares outstanding
6:56
in the wild, and they are trading on the open
6:59
market today at $20 a share. OK, simple enough.
7:02
10 million shares times 20 bucks a share. So
7:06
the total market value, the market cap is 200
7:09
million dollars. Spot on. Now, let's look at
7:12
the hidden claims. Somewhere in the company's
7:14
past, they issued 1 million warrants to an early
7:17
investor. And these specific warrants give that
7:21
investor the right to buy new shares directly
7:23
from the company at $15 a share. $15. But the
7:29
stock is trading on the open market right now
7:30
at $20. Naturally, the warrant holders see this,
7:33
right? And they decide to exercise their rights.
7:35
They push the button. Because it's a great deal
7:37
for them? Exactly. The company is contractually
7:39
forced to issue 1 million brand new shares. In
7:42
exchange, the warrant holders wire the company
7:45
$15 for each of those shares. So the company
7:47
just received $15 million in fresh cash. Let's
7:51
recalculate the total value of the company. It
7:53
was worth $200 million yesterday. It just added
7:56
$15 million in hard cash to its balance sheet
7:59
this morning. So the total value of the business
8:00
is $215 million. Sounds great on paper. The company
8:04
is objectively worth more money than it was yesterday.
8:06
It is. But look at the denominator in that equation.
8:10
Look at the new share count. Right, the new shares.
8:12
We started with 10 million shares. We were forced
8:15
to issue 1 million new ones to the warrant holders.
8:18
So that $215 million of total value is no longer
8:22
divided by 10. It is now spread across 11 million
8:26
shares. OK, let me do that math real quick. If
8:29
we take the $215 million total value. and divided
8:34
by the new total of 11 million shares, that comes
8:38
out to, wait, $19 .55 per share. Down from $20.
8:43
Wow. So what does this actually mean for me,
8:44
the existing shareholder who just held the stock
8:47
and literally did nothing? Well, yesterday your
8:50
shares were worth 20 bucks. Today, purely because
8:52
someone else exercised a contract, your shares
8:54
are worth 19 .55. I just lost about 2 .25 % of
8:57
the value of my investment and I had absolutely
8:59
zero say in the matter. None. The crucial thing
9:02
to understand is why you lost that value. It's
9:04
because the company essentially sold $20 shares
9:07
for $15. Yeah, that makes sense. They sold a
9:09
piece of the underlying business at a steep discount
9:12
to the current market reality. Yes, the 15 million
9:16
in cash they received made the pie slightly larger,
9:20
but they gave away a disproportionate amount
9:22
of equity to get it. So today's shareholders
9:24
are essentially paying the financial price for
9:26
a discounted deal that was negotiated years in
9:29
the past. Exactly. That is a brutal reality check.
9:32
The pie got bigger because of the cash, but it
9:35
was sliced into so many additional pieces that
9:37
my individual slice is objectively less filling.
9:40
And that silent wealth transfer away from you
9:42
and toward the warrant holder is exactly why
9:45
understanding dilution is so critical. All right,
9:48
so if both rights and warrants create new shares
9:50
out of thin air and both of them cause this,
9:53
you know, painful dilution for existing shareholders.
9:56
Why do companies use two different tools? Good
9:58
question. Like, why have a right and a warrant
10:01
if they act the same way on the balance sheet?
10:03
It all comes down to the strategy behind the
10:05
corporate finance. You really have to look at
10:07
who is receiving these instruments and how long
10:11
they last before they expire. It breaks down
10:14
to a difference of sweeteners versus survival.
10:17
Sweeteners versus survival. OK, let me try to
10:19
map this out. Let's imagine an exclusive country
10:22
club. Sure. And the club suddenly needs a bunch
10:26
of money to build a massive new swimming pool.
10:31
Our train first feels like the club going to
10:34
its current loyal members and saying, hey, we're
10:37
doing a cheap expansion. because you've been
10:39
here for years. We're giving you first dibs to
10:41
buy in at a discount so you can maintain your
10:43
VIP status and not get crowded out. Yes. That's
10:46
a great way to think about rights, whereas warrants
10:48
operate on a totally different incentive structure.
10:50
OK, how so? To use your analogy, warrants are
10:53
like the club management handing out long -term
10:55
VIP passes to wealthy outside investors just
10:57
to convince them to fund the pool construction
10:59
in the first place. Ah, I see. And the problem
11:02
is, those VIP passes might be valid for three
11:05
or four years. By the time those outside investors
11:08
finally decide to use them, the pool is already
11:11
built, it's fully paid for, and suddenly these
11:13
outsiders are just crowding your swim lane. So
11:16
they get all the upside long after the initial
11:18
risk is passed. Exactly. Let's look at the mechanics
11:21
of warrants first. As we noted, warrants are
11:24
generally long dated. We're talking lifespans
11:28
of two, three, sometimes five years. That is
11:30
a long time in the market. It is. And they're
11:33
almost always issued as a sweetener to get a
11:35
tough deal over the finish line. Right. Imagine
11:38
a company is struggling to raise capital. Maybe
11:40
they're a high risk mining venture or an early
11:42
stage biotech firm. They go to a large institutional
11:45
investor and say, if you buy a block of our shares
11:48
today at market price, we will also staple a
11:51
warrant to those shares. Giving them the ability
11:53
to buy even more shares at a set price any time
11:56
in the next three years. Exactly. So the institutional
11:58
investor buys the core shares, but they also
12:01
get a long -term lottery ticket just in case
12:03
the company discovers gold or cures a disease.
12:06
And this isn't some rare exotic transaction,
12:08
by the way. In certain sectors, like the Canadian
12:11
small cap and resource markets, this is standard
12:14
everyday plumbing. Really? Oh yeah. Companies
12:17
in those spaces frequently issue what they call
12:19
units, which typically consist of one common
12:22
share plus a half warrant. They have to offer
12:25
that sweetener because the risk of the underlying
12:27
business is so high. Makes sense. But because
12:30
warrants are long dated, they do suffer from
12:32
what we call time decay. If the company's stock
12:35
price goes absolutely nowhere for three years,
12:38
that warrant slowly loses its speculative value
12:41
as the clock runs out and eventually it expires
12:44
worthless. Got it. Warrants go to the big players.
12:47
They act as a deal sweetener and they hang over
12:49
the company for years. Now, what about rights?
12:52
How does the country club treat its existing
12:55
members? Well, rights are practically the inverse
12:57
of warrants. First, they are short -dated. Our
13:00
rights offering usually only lasts a few weeks.
13:02
Wow, that's quick. Very quick. Second, the exercise
13:06
price is deliberately set well below the current
13:08
market price of the stock. And most importantly,
13:12
rights are issued pro rata directly to existing
13:15
shareholders. Pro rata. meaning they are distributed
13:18
proportionally based on how many shares I already
13:21
have sitting in my account. Yes. The entire philosophical
13:25
purpose of a rights offering is to allow you,
13:28
the existing shareholder, to maintain your exact
13:31
percentage of ownership in the company without
13:33
suffering dilution. OK. The company needs cash.
13:36
They're going to issue new shares, but they're
13:39
giving you the very first opportunity to buy
13:40
them. They're basically saying, if you want your
13:43
slice of the pie to stay the same size, here
13:45
is your discounted ticket to keep up with the
13:47
new share count. But this brings up a massive
13:49
flashing practical warning for anyone listening
13:52
to this deep dive. We have to talk about the
13:54
danger of the rights envelope. We really do.
13:57
Because rights are issued automatically to current
13:59
shareholders. You will literally get a physical
14:02
notification in the mail. like a corporate action
14:05
alert pop up in your brokerage portal explicitly
14:08
stating that you've been issued rights. And you
14:11
have a very narrow window to make a decision.
14:13
Right. And you basically have three choices.
14:15
Yeah. Choice one, you participate, you click
14:18
the button, you exercise your rights, you send
14:20
the company more of your cash, and you buy those
14:23
discounted shares. As we saw in the math earlier,
14:27
by doing this, you stay neutral. You bought enough
14:30
new shares to ensure you don't lose your overall
14:32
percentage of the company. Exactly. Choice two,
14:35
you sell the rights. Because these rights inherently
14:38
have value, they literally give whoever holds
14:41
them the power to buy stock at a steep discount,
14:44
you can turn around and sell those rights to
14:46
another investor on the open market. OK. Again,
14:49
from a wealth perspective, you stay relatively
14:51
neutral. You suffer the dilution. But you receive
14:54
a lump sum of cash from selling the rights that
14:56
compensates you for the drop in your share value.
14:59
But choice three. Choice three is ignoring it.
15:02
And this is where it gets incredibly dangerous
15:04
for retail investors. Oh, absolutely. Think about
15:07
how much physical mail you get from your brokerage
15:09
that looks like dense legal jargon which just
15:12
goes straight into the shredder. Or how many
15:14
unread alerts sit in your trading app. Too many.
15:18
If you get a rights offering and you ignore it,
15:20
you are mathematically guaranteed to lose money.
15:23
It is the only choice out of the three with a
15:25
guaranteed unrecoverable loss. Let's put the
15:28
hard numbers to this straight for the research.
15:30
Let's say you own 400 shares of a stock that's
15:33
currently trading at $20. Your total investment
15:36
is worth $8 ,000. OK, following. The company
15:39
announces a one -for -four rights offer, letting
15:42
shareholders buy new shares at a discounted price
15:44
of $16. Because you own 400 shares, the pro rata
15:48
math dictates you receive enough rights to buy
15:51
100 new shares. But you're busy. You don't read
15:53
the mail, you let the few weeks pass, and the
15:56
rights simply expire. The broader offering still
15:59
goes through. Everyone else participates. The
16:01
new cheap $16 shares flood the market. The overall
16:04
stock price adjusts downward to account for the
16:07
heavy dilution. Right, because of the extra shares.
16:09
Exactly. In this specific scenario, the theoretical
16:12
price drops to $19 .20. Now, you still have your
16:16
original 400 shares sitting in your account,
16:18
but they are no longer worth $20. They're worth
16:20
$19 .20 each. Which means your initial $8 ,000
16:23
investment is now only worth $7 ,680. You started
16:28
with $8 ,000. You ended with $7 ,680. You just
16:31
lost $320, not because the company had a bad
16:35
quarter, not because the market crashed. You
16:36
lost 320 bucks simply because you didn't open
16:39
your mail. And we have to ask, where did that
16:41
$320 actually go? Good point. Where did it go?
16:44
It didn't just evaporate into the ether. It was
16:46
transferred directly to the shareholders who
16:49
did pay attention, who exercised their rights
16:51
and bought the discounted shares. Wow. A rights
16:54
offering where you do nothing is quite literally
16:56
a wealth transfer from the inattentive investor
16:59
to the attentive investor. That is wild to think
17:02
about. The lesson there is simple. Open your
17:05
brokerage mail, folks. Treat corporate actions
17:07
like actual cash, because they are. Truly. So
17:11
we know rights offerings will show up loudly
17:13
in our inbox. But what about warrants? There
17:15
are all these hidden warrants out there, issued
17:17
years ago, waiting in the shadows to dilute our
17:20
shares. How do you as a retail investor spot
17:22
these financial landmines before you decide to
17:24
buy a stock? That brings us to our early warning
17:27
system. You have to learn how to look past the
17:30
headline numbers that the finance sites feed
17:32
you. It's like reading the nutritional label
17:34
on a box of snacks at the grocery store. If you
17:37
just look at the bright marketing on the front
17:38
of the box, it screams only 100 calories and
17:42
low fat. It looks incredibly healthy. Right.
17:45
But you have to physically turn the box around
17:47
and read the tiny fine print on the back to realize
17:50
it's packed with 30 grams of hidden sugar. You
17:53
can't just trust the headline. That is the perfect
17:55
framework for how you should approach corporate
17:57
earnings reports. The front of the box number
18:00
that everyone quotes on television and that most
18:02
basic stock screeners display is basic EPS, basic
18:06
earnings per share. OK, yeah. We all know the
18:08
concept of EPS. You take the company's net income,
18:11
their profit, and divide it by the number of
18:13
shares. So if they made $18 million and they
18:16
have 10 million shares, their basic EPS is $1
18:19
.80. Clean, simple, and it looks great on the
18:23
front of the box. But Basic EPS ignores the hidden
18:27
shire. It only calculates the shares that actually
18:29
exist today. It completely ignores the warrants,
18:32
the convertible debt that can be swapped for
18:34
equity, and all the unexercised options lurking
18:37
off balance sheet. That is why, before you invest,
18:40
you must look at the back of the box number.
18:43
diluted EPS. How does the math change when we
18:47
flip the box around to diluted EPS? Well, diluted
18:49
EPS forces the company's accountants to answer
18:52
a very uncomfortable worst case scenario question.
18:55
Which is? What would our earnings per share look
18:57
like if every single warrant, every single piece
19:00
of convertible debt, and every single option
19:03
that could legally become a share actually did
19:06
become a share today? So it assumes maximum possible
19:09
dilution has already happened. Exactly. It artificially
19:12
inflates the share count in the denominator to
19:14
show you the absolute worst -case scenario for
19:16
your slice of the pie. Let's look at the numbers
19:18
from the source material we pulled. That exact
19:20
same company we just mentioned had a very healthy
19:23
basic EPS of $1 .80. But when the accountants
19:27
were forced to factor in all their outstanding
19:29
warrants and convertibles, the theoretical share
19:32
count jumped from 10 million all the way up to
19:35
11 .5 million. Right. Suddenly, that profit is
19:38
spread much thinner and the diluted EPS drops
19:41
to $1 .57. That's a massive drop from 1 .80 down
19:46
to 1 .57. That is nearly a 13 % gap between the
19:50
headline number and the reality number. And that
19:52
13 % gap is your early warning system. It is
19:55
a massive flashing siren. If you see a wide delta
19:59
between basic EPS and diluted EPS, the financial
20:02
statements are screaming at you that there are
20:04
substantial claims on this company's future cash
20:06
flows that are not reflected in the current share
20:08
account. So when you pull up a stock quote on
20:11
a free finance app, and you see a P -E ratio,
20:14
a price to earnings ratio, which earnings number
20:16
do you think those algorithms are usually using?
20:19
Let me guess. Basic EPS. Basic stock screeners
20:22
and media coverage almost always default to using
20:24
the basic EPS. Why? Because it makes the company
20:27
look better. Of course it does. The earnings
20:29
look higher, which makes the P -E ratio look
20:31
cheaper, which attracts more investors. But for
20:34
you, the individual investor trying to protect
20:37
your capital, diluted EPS is the only honest
20:40
version. Because those claims are real. Very
20:42
real. Those claims, those warrants exist right
20:45
now, whether the holders have pushed the exercise
20:47
button yet or not. They are a permanent overhang.
20:50
on the stock's potential to appreciate. The takeaway
20:53
here is absolutely crucial. Never just blindly
20:56
trust the headline PE ratio. Scroll down and
20:59
check the diluted EPS. If the gap is wide, you
21:02
know there are backdoor tickets just waiting
21:04
to be printed the second the stock price goes
21:06
up. It really is about knowing exactly what you're
21:08
buying. When you purchase a share of stock, you're
21:11
buying a percentage of that company's future
21:13
cash flows. If the denominator, the share count,
21:16
is structurally destined to grow faster than
21:18
the actual cash flows, your investment is fighting
21:21
a steep uphill battle from day one. OK, let's
21:24
bring this all home and synthesize what we've
21:26
unpacked today. We started with the dilution
21:28
distinction. We established that exchange traded
21:31
options are just contracts between you and me,
21:34
peer to peer, fan to fan in the parking lot.
21:36
Right. They transfer existing shares and they
21:39
do absolutely nothing to dilute the company's
21:41
overall share count. The company is not a party
21:44
to the option contract, so no new shares are
21:46
ever created. But rights and warrants are a totally
21:49
different beast. They're issued directly by the
21:51
company. When they're exercised, brand new shares
21:54
are forced into existence. Yes. The share count
21:57
goes up. The cash the company receives almost
21:59
never covers the true market value of the equity
22:02
they just gave away. And ultimately, your slice
22:05
of the pie shrinks. Which is exactly why you
22:07
have to take active steps to protect yourself.
22:10
You protect yourself in two very practical ways.
22:12
First, you actually open your brokerage mail.
22:14
Please open your mail. Seriously, if you get
22:17
a rights offering, you must either participate
22:20
and buy the shares or sell the rights to someone
22:23
else. If you throw the envelope in the trash
22:25
and do nothing, you are mathematically guaranteed
22:28
to lose money, literally handing your wealth
22:30
over to the shareholders who are paying attention.
22:33
And second, you use the early warning system
22:36
before you ever buy a stock. You compare basic
22:39
EPS to diluted EPS. A wide gap between those
22:43
two numbers means there are warrants and convertible
22:45
debt lurking in the shadows, just waiting for
22:48
the right moment. to dilute your stake. It's
22:51
honestly incredible how much complex plumbing
22:53
happens behind the scenes of a simple stock purchase.
22:56
We log into our apps and think we're just buying
22:58
a piece of a business, but we're actually buying
23:00
into a deeply complex web of competing claims
23:03
and hidden contracts. It is a lot to process.
23:05
And I actually want to leave you with one final
23:07
slightly frustrating twist to mull over as you
23:10
look at your portfolio. Oh, boy. What is it?
23:12
Well, we just spent this entire deep dive establishing
23:14
the absolute rule that options do not dilute
23:17
you because the are traded between peers on an
23:20
exchange. Right, the parking lot transaction.
23:23
The fans trading tickets. But there is one massive
23:26
glaring exception in the corporate world. Employee
23:29
stock options. Oh, no. Wait, really? Oh, yes.
23:33
When a company decides to compensate its executives,
23:35
its engineers, and its workers with options,
23:38
they aren't going to the open market and buying
23:40
contracts from other traders to hand out. They're
23:42
making them themselves. Exactly. The company
23:44
is issuing those options directly to the employees.
23:48
Which means, from an economic standpoint, employee
23:51
stock options function exactly like warrants.
23:54
So when an executive decides to exercise their
23:57
options and clash out, the company is printing
23:59
new shares. Brand new shares. And you, the retail
24:02
shareholder who thought you were safe, are absolutely
24:05
being diluted to pay for that compensation. That
24:08
is wild. So the very next time you read a press
24:10
release and hear that a tech company is heavily
24:13
relying on options to retain talent, You have
24:16
to ask yourself a critical question. What's the
24:18
question? Are we talking about anonymous traders
24:20
swapping contracts on a secondary exchange? Or
24:24
are we talking about executives standing at the
24:26
back door of the stadium printing thousands of
24:29
new tickets to the concert? And just like that,
24:32
the financial x -ray machine gets murky again.
24:35
You thought you got a clean 10 % of the pie.
24:37
But depending on who is holding the institutional
24:39
warrants and who is holding the employee options,
24:42
someone else holds a button that can quietly
24:44
shave your slice down to nine. Exactly. Know
24:47
the distinction between the instruments. Always
24:49
read the diluted earnings numbers and whatever
24:51
you do. Sorry, whatever you do, open your mail.