Value Erosion Through Corporate Investment

Illuminating article about how companies investing in new directions could be just eroding shareholder value.

"So I'm growing and I put in $100 million to fund the growth. Now, there are three possibilities. One is that I'm beating my head against a highly competitive market where other people are frankly better positioned than I am. Suppose my cost of capital, what I had to pay to raise that $100 million, was 10%. Well, I'm going to earn a lot less than that 10% in that market. So I'm going to pay 10 million a year, which is 10% of 100 million to raise the money. I'm going to invest it at 8%, which is 8 million a year. I'm going to lose 2 million a year. So the growth destroys value in that case for the existing shareholders. And the way it gets disguised, of course, is that they are taking it away from themselves. They don't go out and raise the money. They just reinvest their earnings in a way that loses money. Anyway, but it still dissipates value."

Fool.com: Identifying Franchises [Commentary] August 12, 2004