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By Philip van Doorn

The Big Tech companies known as hyperscalers may be tempted to issue more shares as interest rates rise and the stock market holds up, which can hurt their current shareholders

Alphabet and Meta have both reversed their long-term policies of lowering share counts through buybacks, instead carrying out massive dilutive stock offerings to help fund the AI infrastructure buildout.

One thing stock-market investors should watch out for is having their ownership of a company reduced through no action of their own.

That's known on Wall Street as being diluted, which is the lowering of an investor's ownership percentage when a company issues common stock to raise money for expansion or to pay for an acquisition, or to shovel shares to executives as part of their compensation.

Dilution raises a company's share count and lowers its earnings per share. The opposite move - buying stock back - lowers the share count and raises EPS.

A rising share count isn't necessarily bad for a company's investors. The money being raised, without adding to a company's debt burden, might be used for lucrative long-term expansion. But it is something to keep an eye on during the scramble for funding to pay for the artificial intelligence-infrastructure buildout.

And some confusion springs from how companies describe these activities and their habit of issuing new shares (at least as part of executives' compensation packages) and buying back shares at the same time.

When a company says it is "returning capital to shareholders" through buybacks, that's not necessarily true. It is one thing for a company with excess capital to call dividend payments a "return" of investors' money, but buybacks are really the deployment of capital to buy shares from people who no longer wish to be owners of the company.

Sometimes buybacks merely mitigate the dilution caused by a company's issuance of stock to give to its employees as part of their pay packages. When buybacks outweigh issuances, we have net buybacks, which lower the share count and increase EPS.

'Apple's repurchases did the job.'Former Berkshire Hathaway CEO Warren Buffett in his 2021 letter to shareholders

Share counts for the largest S&P 500 companies

Here are the largest 10 companies in the S&P 500 SPX, ranked by market capitalization and showing how much their quarterly average diluted common share counts (used to calculate earnings per share) have changed over the past one, three, five and 10 years. The share counts are as of the companies' most recently reported fiscal quarter ending dates, through Tuesday. That means the most recent information may not be on the table, and there is more about that below.

Meta's (META) average diluted share count during the third quarter was unchanged from a year earlier, and the company had lowered its share count considerably over the previous 10 years. But on Oct. 22, Meta announced a set of common and mandatorily convertible preferred stock offerings to raise as much as $95 billion. Those preferred shares will convert to common shares in August 2029, adding to the dilution.

The offerings include underwritten and at-the-market sales of new shares. They will be priced differently over time. But using back-of-the-envelope calculations, based on Meta's closing share price of $621.03 on Tuesday, $95 billion would make for 152,971,676 new shares, or 5.9% of the company's third-quarter average diluted share count of 2.573 billion.

What does that type of dilution mean? If a company's share count increases by 5.9%, its earnings per share will decline by 5.6%, all things being equal.

Among the 10 largest components of the S&P 500, Alphabet (GOOGL) showed the highest dilution of its combined common share count for one year through Sept. 30. This marked a reversal of a long-term trend of a declining share count.

The company began this funding wave during the second quarter, raising $49.6 billion through a combination of common and mandatorily convertible stock offerings. This was followed by another $12.4 billion raised in the third quarter through the issuance of common shares. The company said it planned to use the money raised to help in the buildout of AI infrastructure and computing power.

For the three- and five-year periods, Broadcom (AVGO) showed the largest increases in share counts among the companies on the list. For 10 years, Tesla (TSLA) has led with a 50.4% increase in its diluted share count.

When it comes to share-count reductions through net buybacks, Apple (AAPL) dominates this list of companies. The company's quarterly average diluted share count has declined 32.2% over the past 10 years, as it has spent a combined $769.32 billion on share repurchases, according to FactSet.

There is a compounding effect when share counts are reduced. That 32.3% decline in the share count has made for a 47.5% boost to the iPhone maker's EPS, all else equal.

Apple's buybacks and Warren Buffett's gratitude

Ideally a company's buybacks will be timed for when the shares are attractively priced in the market, but often this is not the case. In his 2019 letter to shareholders, former Berkshire Hathaway (BRK.B) (BRK.A) CEO Warren Buffett, who remains on the company's board of directors, discussed "the sense and nonsense of stock repurchases." He wrote: "Berkshire will buy back its stock only if a) Charlie and I believe that it is selling for less than it is worth and b) the company, upon completing the repurchase, is left with ample cash." He was referring to the late Charlie Munger, who was then the company's vice chairman.

In the same letter, Buffett expressed a desire for Berkshire's share count to decline. "If the price-to-value discount (as we estimate it) widens, we will likely become more aggressive in purchasing shares. We will not, however, prop the stock at any level."

So companies can overspend on buybacks, continuing to repurchase even when their shares are trading at historically high levels to earnings, cash flow or book value.

On the other hand, we can go back to Buffett for an example of how rewarding a steady buyback policy can be. In his 2021 shareholder letter, he cited Berkshire's stake in Apple's common stock, which increased to 5.55% at the end of 2021 from 5.39% at the end of 2020. "That increase sounds like small potatoes. But consider that each 0.1% of Apple's 2021 earnings amounted to $100 million. We spent no Berkshire funds to gain our accretion. Apple's repurchases did the job," he wrote.

What all this data means

Stock issuances can be good or bad. The same can be said of buybacks. You as an investor need to be aware of both of these activities by the companies you own. Spikes in issuance such as the current moves by Alphabet and Meta, and long-term trends such as Apple's dedication to buybacks, can help you to form your own opinions as you make long-term investment decisions.

-Philip van Doorn

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

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11-04-26 1244ET