Sep
08
2023
Understanding Diluted EPS

Understanding Diluted EPS

By | Growing Wealth, invest, Investing, Terminology | Comments Off on Understanding Diluted EPS

Diluted earnings per share (EPS) is a measure of earnings per share that includes a company’s convertible securities. Convertible, or dilutive, securities are stocks or bonds that could potentially become common shares. Basic earnings per share only considers existing common shares.

Diluted EPS, then, includes in its calculation the factor of convertible bondholders, convertible preferred stockholders, and options holders potentially deciding to turn their securities into common shares. If this were to happen, the number of shares outstanding would increase, with earnings staying the same, resulting in lower earnings per share. Diluted EPS will therefore tend to be lower than basic EPS.

Basic vs. Diluted EPS

What is diluted earnings per share, and how does it differ from basic EPS? Simply put, basic EPS tends to be a higher number than diluted EPS. Basic EPS doesn’t factor in the existence of convertible securities of the impact if they were to be converted into common shares.

Instead, the most basic calculation of earnings per share only takes a company’s net income minus any preferred stock dividends and divides that number by the number of shares outstanding. Convertible securities aren’t factored into the equation.

Because of this, sometimes it’s beneficial to look at a calculation of earnings per share that assumes all possible common shares have been brought into being through existing convertible securities. Doing so gives investors a more realistic view of earnings while assuring no future surprises.

Imagine an investor doing all their homework on the fundamental analysis of a company using only basic earnings per share. EPS, which measures the value that a company delivers to individual shareholders, might look high and the stock pays a good dividend, so the investor might decide the stock is a good one to buy.

But then she learns that the company has been issuing convertible bonds to raise capital and giving new employees stock options to make working there more attractive.

All of a sudden, for some reason, bondholders decide to convert their bonds to common shares, and employees decide to exercise their stock options.

Now this investor’s shares have been diluted, since a bunch of new shares have popped into existence practically overnight. As a result, earnings per share have decreased, and dividends likely have done the same (because the same dividends now have to be paid out to additional shareholders).

If our imaginary investor had used diluted EPS in her calculations, she could have prepared for this kind of scenario at some point. But because this make-believe company created the potential for its stock to be diluted by issuing convertible securities, basic EPS did not provide the full picture.


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How to Calculate Diluted EPS

The formula for diluted EPS is a company’s net income minus any preferred stock dividends, divided by the company’s average outstanding shares minus its dilutive shares. Or:

Diluted EPS = (Net Income – Preferred Stock Dividends)/(Average Outstanding Shares – Dilutive Shares)

The diluted EPS formula is calculating the amount of earnings per share there would be if dilutive shares were to become common shares. The formula is exactly the same as that of calculating basic EPS, but with one important extra step – adding the number of dilutive shares to the number of average outstanding shares (in the bottom half of the equation).

The sum of both existing common shares and the possible dilutive shares creates a larger number on the bottom half of the equation, while the top half remains the same.

Therefore, diluted EPS tends to be lower than basic EPS, as the company’s net income (minus preferred stock dividends) is being divided by a larger number of shares.

For example, let’s say a company makes $1,000,000 in net income and pays no dividend. There are 800,000 common shares outstanding, 100,000 call options, and 100,000 convertible preferred shares.

The diluted EPS formula would yield a result of $1.00 per share in this example, as we would be dividing 1,000,000 dollars in net income by 1,000,000 total potential shares.

Basic EPS, on the other hand, would be calculated as $1,000,000 divided by the 800,000 current shares, yielding a result of $1.25 per share.

While it’s not difficult to calculate EPS and diluted EPS, many companies share the figures with investors in their earnings reports.

Recommended: What You Should Know About Earnings Calls

Why Is Diluted EPS Important?

Diluted EPS reveals what a company’s earnings per share could look like if holders of convertible securities were to decide to exercise their right to hold common shares, and it’s an important consideration during an investor’s analysis of a stock.

Since companies often issue convertible securities like stock options, convertible bonds, convertible preferred shares, a company’s earnings per share could appear higher than reality when not factoring in the potential for dilution.

Convertible securities might be held by people inside or outside of the company, and they may not be turned into shares anytime soon. But what happens when everyone decides to turn in their convertible securities for shares?

For example, if a company’s stock were to rise in price suddenly, and the company had paid several of its employees bonuses in the form of stock options, those employees might choose to exercise those options.

Now there are more common shares than before, but earnings have not increased. Therefore, in a theoretical example like this, earnings per share will have decreased.

A company issuing employee stock options isn’t always a negative thing, however. If the options keep high-quality employees, the result could be positive for the company over the long run. Using options also reduces expenses that come from paying employee salaries, which could free up capital to help the company grow.

Diluted EPS provides a more conservative earnings per share number since it shows what EPS would be in the event of more new shares coming into existence. Basic EPS could appear to be deceivingly high because it doesn’t calculate for this possibility, so it could be a less reliable indicator of when to buy, sell, or hold a stock.

Of course, there might also be times when diluted EPS is unnecessary. Young companies that are still small and growing might not have had the chance to issue any convertible securities yet, so earnings per share might look the same either way.

The Takeaway

Diluted EPS is a measurement of earnings per share that factors in the potential stock dilution that occurs when convertible securities are converted to common shares. Understanding diluted EPS is important so that investors don’t get caught off guard in the event of new common shares being created through the conversion of securities such as stock options, stock warrants, convertible bonds and convertible preferred shares.

When this happens, earnings per share decline, and those who had only been looking at basic EPS in an attempt to determine the profitability of a company will find they made a miscalculation. In some cases, the difference between basic and diluted EPS might not be that different. If a company hasn’t issued convertible securities, or has issued very few convertible securities, then not much dilution would be possible.

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Sep
07
2023
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What Is Buying In Bulk?

By | Budgeting & Goals, money | Comments Off on What Is Buying In Bulk?

Buying in bulk means purchasing large quantities of a single product at a lower cost than you’d usually pay for the item. For example, you might buy a six-pack of shampoo for less than the per-unit price you typically spend on a single bottle. Or you might save big by buying a 10-pound bag of grapes instead of the usual one- or two-pounder.

But, like many things in life, buying in bulk has its pros and cons. For instance, you probably have to shell out more upfront to purchase larger quantities, and you might have trouble storing the items or using them up before their expiration date.

Here, you’ll learn more about this topic, including:

•   What is buying in bulk?

•   How much can you save by buying in bulk?

•   What are the pros and cons of buying in bulk?

•   What are tips for bulk shopping?

How Much Is “Bulk”?

How much is bulk doesn’t have an exact answer. There is no specific quantity you need to purchase to have something qualify as bulk buying. Rather, the term means you are buying large quantities of a single item to reap a discount.

That might mean you are buying one jumbo box of cereal (the kind that could feed a cabin full of summer campers) or a 12-pack of regular-size boxes bundled together. You might be buying 36 eggs at a time vs. the usual dozen.

The point is, it’s a larger quantity than what you might find at your local supermarket and at a lower price. And when you buy in bulk and save, you may be helping your overall financial health, too.

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The Pros of Buying in Bulk

A firm financial foundation starts with saving. While the big deal is the potential for saving money on the cost per item, there are other reasons to shop in bulk.

You’re Saving Money

Who isn’t looking for ways to save money daily? If you are wondering, “Does buying in bulk save money?” the answer is usually yes. By buying in bulk, you can likely enjoy a double-digit discount vs. supermarket prices.

You’re Helping the Environment

It can be more socially responsible and environmentally friendly because bulk purchases usually have significantly less packaging per use than smaller purchases have. (Envision a mammoth pickle jar or tub of frosting.)

Ideally, buying in bulk also means you shop less, and that’s less time spent on the road and burning gas.

You May Avoid Impulse Buys

You may rack up additional savings just by being in the store less frequently and having fewer opportunities to pick up things that weren’t on your list. If you’re motivated to save money, avoiding those impulse purchases can be a big plus.

You May Plan and Budget Better

If you’re the organized type who is big on preparing meals in advance, cooking lots of food and freezing it, buying in bulk can make that endeavor easier. That, in turn, can help you take better control of your food budget.

For sure, it’s cost efficient to prepare your family’s favorite pasta dishes and soups and have enough for today and whenever you’re ready for round two or three.

Finding the Price Per Unit

If saving money is important to you, there’s a good chance you want to know exactly how much you are benefiting by buying in bulk. To figure out the real cost you are paying, this is one time you need to do the math. To capitalize on a bulk buy, determine the cost per unit. Sometimes, this number will be listed on the price signage at the store; otherwise, you can use the calculator function on your mobile phone.

•   What is a unit? Think measurements like ounces, square feet, grams, and gallons. For example, a bottle of olive oil is not a unit. A fluid ounce of olive oil is. A roll of paper towels is not a unit. A square foot of paper towels is.

•   Figure out how many units you are buying. Take the total cost of your purchase and divide that by the number of units to get the price per unit.

•   Then compare the unit prices of a few packages of the same product to determine which is the better value.

Ideally, the cost per unit of a bulk buy should be 20% to 35% below what you would normally pay at the supermarket.

Although a supersized item usually has a lower cost per unit than its smaller brethren, crunch the numbers to see.

How Much Can You Save By Buying in Bulk?

No doubt, it can be hard to save money today, and you may wonder whether buying in bulk is worth it. The answer is: It depends. While the amount shoppers save depends on the item, they can anticipate saving around 25% on purchases, according to one recent study across 20 categories of products. Another study found savings of up to 35% at the wholesale clubs vs. supermarkets.

You can also up your savings from buying in bulk by using coupons for those items.

Remember, what’s important isn’t an item’s price but the price per unit.

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3 Tips for Buying in Bulk

When you want to stop spending so much and begin buying in bulk, you need a game plan. It’s a good idea to reach for the familiar and sweeten the deal by looking for familiar items that are also on sale. That will snag you the best prices and help keep your bank account well padded.

1. Stick With What You Know

This is not the time to experiment. If you’re loading your cart with goods, you don’t want to be guessing about whether you’ll love them or not. Go for the family’s beloved items.

Buying in bulk and getting a deal is worthless if nobody wants to eat or use what you buy. That’s money down the drain.

2. Search for Your Favorites on Sale

Don’t want to buy what’s on sale solely because it’s on sale. When trying to cut your grocery bill, the goal is to get what you know and love on sale, not to be overly adventurous. The latter can leave you disappointed, with a few fewer dollars in your pocket to boot.

3. Keep Expiration Dates in Mind

Do check expiration dates when buying in bulk. Items can expire before you get to use them, which is akin to throwing away your hard-earned money. Everything from sunscreen to olive oil can deteriorate when left to sit for long periods because you bought a mega-pack, so shop carefully.

What to Buy in Bulk and What to Avoid

Some products are perfect for stockpiling. While your list will depend on your family, think of items like:

•   Paper towels

•   Toilet paper

•   Tissues

•   Detergent

•   Dishwashing liquid

•   Sponges

•   Aluminum foil and plastic wrap

•   Toothpaste

•   Canned beans and fish

•   Frozen foods

•   Rice

•   Sugar

•   Flour

On the flip side, generally, you don’t want to load up on fresh produce unless you are cooking for a crowd, as your family may not be able to eat it all before it wilts or gets moldy.

The Cons of Buying in Bulk

Buying in bulk can work to your advantage, but it’s not without caveats.

Larger Quantities Can Mean Spending More

Paying $40 for $60 worth of lotion may be a good deal, but what if $40 puts a bigger squeeze on your budget than buying individual bottles one at a time, weeks apart? If you use a credit card in order to buy bulk and save, can you pay off the entire bill when it’s due. If you incur interest charges, that will eat into your “savings.”

You’ll Need Storage Space

Keep in mind, too, that you need space to store all that stuff and a car to pile it in to take home. If either of these are issues, buying in bulk may not be ideal for you.

You May Get Bored With Bulk Products

Know thyself…and your family. Maybe you are the person who gets bored quickly, or your kids will beg for some variety after you’ve bought 24 boxes of the same cereal. When you’ve got mega amounts of the same product, be prepared for the “same old, same old” for a long stretch. That’s all the more reason to purchase only what you love, as you may be using it for months.

You May Have to Pay Membership Fees

If you’re going deep into bulk buying, you likely won’t settle only for what you can get in bulk at the grocery store but will want to shop at the warehouse stores like Costco and BJ’s. Consider the annual membership fees that are required.

Costco’s “Gold Star” membership is $60, and the “Executive” level is $120. BJ’s tiers are $55 and $110. Sam’s Club advertises membership fees of $50 and $110.

Will you frequent the store enough to make the fee worthwhile?

Bulk Quantities Can Lead to Overuse

If you have something in abundance, it’s all too easy to be less conscious of how much you’re using. Knowing you have 12 rolls of paper towel stashed away could lead you to use it up more quickly because you know you have backup waiting.

Bigger Quantities Means Spending More Cash

There’s also the issue that if you’re earning a lower income and/or have considerable debt, you may not be able to come up with enough money to purchase bulk products versus their smaller and less expensive single-use versions. One big purchase could blow your weekly budget. If you spend a chunk of money to buy a mega-pack of toilet paper, can you then afford other necessities?

Products May Expire

Buying in bulk can be a fun way to save money, but don’t get so giddy grabbing great buys that you forget important things like expiration dates. Products like bleach and sunscreen may expire in 12 months or less. And certainly food products can expire as well. Getting a gallon of milk for the same price as a half gallon doesn’t do you much good if it sits in your fridge for so long that it goes bad.

Buying in Bulk at Local Grocery Stores vs Wholesale Retailers

You may wonder if you should buy in bulk at your local grocery store vs. at a wholesale retailer (meaning places like Costco or Sam’s Club). It’s true that you may find good deals at your local supermarket (such as buy two cans of tuna and get two for half-price), and coupons can boost your savings.

However, it’s likely that it will be the occasional or somewhat regularly available items that are worth buying in bulk locally. At a wholesale retailer or wholesale club, the business model is to have bulk quantities always available at good prices. That’s the company’s mission and what gives them bargaining power. In other words, their reason for being is to help customers buy bulk and save.

While you may find great deals at your neighborhood grocery store that encourage you to stock up, you are likely to find smart deals in every aisle of a bulk retailer.

The Takeaway

Buying in bulk has its advantages. Getting a good deal can keep you motivated to save money, but you’ll need to be savvy. Buy only what you need and what you can comfortably store and use in a timely fashion.

As with your local supermarket, temptation likely lurks at bulk retailers. It’s best to know how to compare cost per unit and to prepare and follow a shopping list.

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FAQ

How much do you save if you buy in bulk?

While individual savings will vary, one recent study found that you can save up to 25% by buying in bulk.

Why is it cheaper to buy in bulk?

When you buy in bulk, you are purchasing items that involve less manufacturing and packaging time and materials (aka economies of scale). They may also offer savings on marketing and distribution costs. These price breaks are passed along to you when you buy in bulk.

What are 2 downsides of buying in bulk?

Here are two downsides of buying in bulk: It can involve paying more upfront (say, purchasing 12 boxes of cereal vs. one at a time), and the products can expire or otherwise go bad before you can use them up.

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Sep
07
2023
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What Investors Should Know About Spread

By | Growing Wealth, invest, Investing | Comments Off on What Investors Should Know About Spread

A spread represents the difference between any two financial metrics. The type of spread depends on the type of security that’s being traded. For example, when trading bonds, the spread can refer to a difference in yields between bonds of varying maturity lengths or quality.

Further, while there are many differences between bonds and stocks — spread is just one of them. With stocks, though, spreadgenerally refers to differences in price. Specifically, it measures the gap between the bid price and the ask price. Understanding what is spread and how it works can help you more effectively shape your investment strategy.

What Is Spread in Finance?

As noted, spread is the difference between two financial measurements. When talking specifically about a stock spread, it is the difference between the bid and ask price.

The bid price is the highest price a buyer will pay to purchase one or more shares of a specific stock. The ask price is the lowest price at which a seller will agree to sell shares of that stock. The spread represents the difference between the bid price and the ask price.

A good way to visualize spread may be to think of buying a home. As a home buyer, you may have a set price that you’re willing to pay for a property, based on what you can afford and what you’ve been pre-approved for by your mortgage lender.

You search for homes and eventually find one that has everything on your wishlist. When you check the listing price, you see that the seller has it priced $10,000 above your budget. In terms of spread, the maximum amount you’re willing to offer for the home represents the bid price, while the seller’s listing price represents the ask.

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What Does Spread Mean?

Aside from stock spread, spread can have a variety of applications and meanings in the financial world.

As mentioned earlier, bond spread typically refers to differences in yield. But if you’re trading futures, the spread can measure the gap between buy and sell positions for a particular commodity. With options trading, it can refer to differences in strike prices when placing call or put options.

Spread can also be used in foreign currency markets or forex (foreign exchange market) trades to represent the difference between the costs for traders and the profits realized by dealers.

With lending, spread is tied to a difference in interest rates. Specifically, it means the difference between a benchmark rate, such as the prime rate, and the rate that’s actually charged to a borrower. So for example, if you’re getting a mortgage there might be a 2% spread, meaning your rate is 2% higher than the benchmark rate.

Bid-Ask Price and Stocks Spread

If you trade stocks online, it’s important to understand how the bid-ask price spread works and how it can affect your investment outcomes. Since spread can help gauge supply and demand for a particular stock, investors can use that information to make informed decisions about trades and increase the odds of getting the best possible price.

Normally, a stock’s ask price is higher than the bid price. How far apart the ask price and bid price are can give you a sense of how the market views a particular security’s worth.

If the bid price and ask price are fairly close together, that suggests that buyers and sellers are more or less in agreement on what a stock is worth. On the other hand, if there’s a wider spread between the bid and ask price, that might signal that buyers and sellers don’t necessarily agree on a stock’s value.

What Influences Stock Spreads?

There are different factors that can affect a stock’s spread, including:

•   Supply and demand. Spread can be impacted by the total number of outstanding shares of a particular stock and the amount of interest investors show in that stock.

•   Liquidity. Generally, liquidity is a measure of how easily a stock or any other security can be bought and sold or converted to cash. The more liquid an investment is, the closer the bid and ask price may be, since it can be easier to gauge an asset’s worth.

•   Trading volume. Trading volume means how many shares of a stock or security are traded on a given day. As with liquidity, the more trading volume a security has, the closer together the bid and ask price are likely to be.

•   Volatility. Measuring volatility is a way of gauging price changes and how rapidly a stock’s price moves up or down. When there are wider swings in a stock’s price, i.e. more volatility, the bid-ask price spread can also be wider.

Why Pay Attention to a Stock’s Spread?

Learning to pay attention to a stock’s spread can be helpful for investors in that they may be able to use what they glean from the spread to make better decisions related to their portfolios.

In other words, when you understand how spread works for stocks, you can use that to invest strategically and manage the potential for risk. This means different things whether you are planning to buy, sell, or hold a stock. If you’re selling stocks, that means getting the best bid price; when you’re buying, it means paying the best ask price.

Essentially, the goal is the same as with any other investing strategy: to buy low and sell high.

Difference Between a Tight Spread and a Wide Spread

As discussed, a tight spread could be a signal to investors that buyers and sellers are more or less in agreement that a stock is valued correctly. A wide spread, on the other hand, may signal that there isn’t necessarily a consensus on what the stock’s value should be.

There’s no guarantee, of course, that that inclination is correct, but when looking at tight or wide spreads, it can be yet another useful piece of information to help inform decisions.

Executing Stock Trades Using Spread

If you’re using the bid-ask spread to trade stocks, there are different types of stock orders you might place. Those include:

•   Market orders. This is an order to buy or sell a security that’s executed immediately.

•   Limit orders. This is an order to buy or sell a security at a certain price or better.

•   Stop orders. A stop order, also called a stop-loss order, is an order to buy or sell a security once it hits a certain price. This is called the stop price and once that price is reached, the order is executed.

•   Buy stop orders. Buy stop orders are used to execute buy orders only when the market reaches a certain stop price.

•   Sell stop orders. A sell stop order is the opposite of a buy stop order. Sell stop orders are executed when the stop price falls below the current market price of a security.

Stop orders can help with limiting losses in your investment portfolio if you’re trading based on bid-ask price spreads. Knowing how to coordinate various types of orders together with stock spreads can help with getting the best possible price as you make trades.

Other Types of Spreads

While we’ve mostly discussed spread as it relates to stocks, there are other types of spreads, too.

Options spreads, for instance, involve buying multiple options contracts with the same underlying asset, but different strike prices or expiration dates.

Under the options spread umbrella are several spreads as well. Box spreads are one example, and they are a type of arbitrage options trading strategy in which traders use some tricks of the trade to reduce their risk as much as possible.

There’s also the debit spread, which is an options trading strategy in which a trader buys and sells an option at the same time — it’s a high-level strategy, and one that may not be suited to investors who are mostly investing in stocks or bonds.

Note, too, that there is something called a credit spread (similar to a debit spread, but its inverse) and that there are some differences traders will need to learn about before deciding to utilize a credit spread vs. debit spread as a part of their strategy. Again, options trading requires a whole new level of market knowledge and know-how, and may not be for all investors.

Investing With SoFi

The more investing terms an investor is familiar with, the better able they’ll be to invest with confidence. Spread is a term that means different things in different situations, but when it comes to stocks, spread is the difference between the bid price and ask price of a given stock. Being able to assess what a spread might mean can help inform individual trading decisions.

As you learn more about stocks, including what is spread and how it works, you can use that knowledge to create a portfolio that reflects your financial needs and goals.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

FAQ

How do you read a stock spread?

A stock spread is the difference between the bid and ask price, so calculating it is a matter of subtracting the bid from the ask price. It’s typically expressed as a percentage.

What is the average spread of a stock?

The average spread of a stock ranges between 13% and 18%, but can vary wildly depending on what types of stocks or market segments are being looked at.

SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
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Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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What Is a Shell Company and Why Do They Exist?

Guide to Shell Companies

By | Growing Wealth, invest, Investing | Comments Off on Guide to Shell Companies

A shell company, also called a shell corporation, refers to any legally structured corporation that has no meaningful assets or business operations. In popular culture, they’re often used to conceal illegal businesses, or to conceal the owners of a business from law enforcement, the public, or both. However, shell companies themselves are not illegal, and they do have some legitimate uses.

As business entities, shell companies exist to protect, and sometimes to conceal (or at least misrepresent) the assets of the shell company’s owner. But there’s nothing necessarily illegal about shell corporations themselves. It’s important to not only understand the definition of a shell company, but also to recognize how and why they’re used by businesses and people.

How Are Shell Companies Created?

There is more than one way to create a shell company. Most often, the people or corporations that launch new shell corporations use a registered agent in the country where the company will have its legal headquarters. So, in the United States, shell companies would need to register with the Securities and Exchange Commission.

In most countries, the agent must register his or her name, and the name of an owner or a shareholder director. The cost of creating and legally registering a corporation will vary from country to country, from as little as a few thousand dollars to as much as several hundred thousand dollars.

Being “hollow,” by definition, shell companies can do many things. They can open bank and brokerage accounts. They can transfer funds in and out of their home country. They can buy and sell real estate or other companies. And own copyrights and earn royalties on those copyrights.

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3 Uses of Shell Companies

People and corporations use shell companies in a wide range of legitimate businesses for legitimate reasons. Those might be used as a vehicle to raise funds, as a legal entity to attempt to take over another business via a reverse merger, or as a legal entity to give form to a company that intends to go public.

1. Tax Benefits of Shell Companies

Many shell corporations operate in a legal gray area, and it’s possible that corporations and wealthy individuals may use them to avoid taxes.

Many companies have found ways to move their profits to offshore shell corporations to take advantage of less expensive, or more permissive tax regimes in other countries (similar to how some states may be more tax-friendly than others). American corporations might set up shell companies in countries with inexpensive labor, where they have already begun to outsource some of their operations.

Corporations aren’t the only ones that use shell companies to avoid paying taxes. Wealthy individuals around the world may also use shell corporations, domiciled all over the world, to hide their earnings and their wealth from the governments of the countries in which they prosper.

2. Less Risk, More Opportunity

Tax avoidance isn’t the only reason a corporation would set up a shell corporation. It might create a shell company to operate in a country, while protecting its other operations from the legal, political, and financial risks related to that country. That way, if something goes wrong in the country where it operates, the parent company can limit its exposure by existing — at least on paper — offshore.

A corporation may also set up a shell corporation in another country to gain a window into new regions. A business might set up a shell company in Panama or Switzerland to gain access to the local business community, in order to generate contacts and information that would lead it to business opportunities in Latin America or Western Europe.

3. SPACs

While shell companies come up in the news in relation to questionable tax-avoidance schemes, in recent years, they’ve also been mentioned alongside special purpose acquisition companies, or SPACs.

At any given time, there may be hundreds of shell companies that qualify as SPACs — which may be a reason that SPACS were so popular for a couple of years in 2020 and 2021. These are companies formed exclusively to raise capital via an initial public offering (IPO), which will then purchase a company already in operation. SPACs are a type of “blank check company.”

These companies issue an IPO, then hold the money in a trust, until the SPAC management team chooses a company and buys it. And if the SPAC doesn’t find a company to buy, or can’t buy the company or companies it likes within a pre-set deadline — often two years — then the managers promise to liquidate the SPAC and give investors their money back.

Recommended: What Is A Backdoor Listing?

Example Shell Companies

An example of a shell company could be as follows.

Say there’s an entrepreneur that’s looking to raise money before they officially launch a startup — maybe the next big emerging growth company. They may create an LLC, which is a business entity, that doesn’t have any assets or employees. It only exists on paper. But the business entity — a shell company — can be used to store the money being raised for the startup prior to its launch.

In effect, the company itself is merely a shell used to hold cash until it’s ready for use. It’s not really a functional business in the traditional sense.

Shell Companies and Shady Dealings

While there are many legitimate uses for shell companies, as outlined, bad actors also might use them to shield their operations and their assets from authorities. And as different jurisdictions compete for business, new loopholes emerge on a regular basis. In Panama, the British Virgin Islands, Nevada and Delaware, to name only a few, there are strong laws that prevent the government from revealing the beneficial owner of a given shell corporation.

And for creative financiers, there are always new ways to add layers of anonymity, such as phony company directors, who agree to sign their names for a few dollars. Among professionals who specialize in such things, there are ways to find would-be board members, and for countries and states with convenient tax and privacy laws.

Are Shell Companies Legal?

Yes, shell companies are legal, and are most often used for perfectly legal purposes. While they can be used for illegal purposes, a shell company is generally used for a more or less boring or run of the mill business purpose — as discussed in the previous example above.

Shell Companies vs Holding Companies

Though there may be some superficial similarities, shell companies and holding companies are not the same thing. As discussed, shell companies may be formed to serve as empty entities that may be used to take advantage of different taxation regulations, for example. A holding company, on the other hand, is a parent company — holding companies holds or owns other companies within it, like an umbrella. It allows its owners to control numerous businesses without necessarily actively managing any of them.

The Takeaway

Shell companies are legal business entities that are often used for perfectly legal reasons, and often to reduce tax liabilities or store funds. Shell companies can be used for illegal purposes, too, which is what they’re often associated with.

Most investors wouldn’t use shell companies in their day-to-day trading, but they might consider allocating part of their portfolios to a SPAC. It’s important to remember that these are speculative, risky investments, so they don’t make sense for every portfolio.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

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FAQ

Is a shell company legal?

Yes, shell companies are legal, and are generally used for perfectly legal purposes. A shell company is simply a business entity that has no assets or employers, or engages in much or any meaningful business operations.

What is an example of a shell company?

An example of a shell company could be an LLC formed by an entrepreneur planning to launch a startup. The entrepreneur files the paperwork to create the LLC, and then uses it simply to store funds until the startup launches, rather than have the LLC engage in any business itself.

What is the difference between a holding company and a shell company?

Holding companies are parent companies, or umbrella organizations, that often have multiple businesses running underneath or within them. Shell companies do not have assets or employees, or any meaningful business operations.

Photo credit: iStock/akinbostanci

SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Claw Promotion: Customer must fund their Active Invest account with at least $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

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07
2023
Is it Smart to Buy Your Leased Car_780x440

Guide to Buying out a Car Lease

By | Budgeting & Goals, money | Comments Off on Guide to Buying out a Car Lease

When a car lease is expiring, you will likely need to decide whether to return the car and find a new one or do a lease buy-out and purchase the car.

Similar to buying a used car, when buying a leased car, you may be able to finance the transaction or pay for it with cash. But how can you know if buying out a car lease makes sense?

The decision will depend on your budget, how much you enjoy driving your leased car, the mileage you’ve put on the car, and the buyout price.

Read on for some key information about a car lease buyout that can help you make an informed decision.

What Does It Mean To Buy Out a Car Lease?

Buying out a car lease involves purchasing the car when your lease agreement comes to an end. It’s a fairly common process, and most lease agreements offer a buyout option. Your leasing company may even reach out to you with different options as the lease agreement nears its end.

Sometimes you can even purchase the car before the lease officially ends. Check your lease agreement to see what the terms are.


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How Does Buying Out a Car Lease Work

Wondering how to buy your leased car? First, consult your lease contract to find out the terms and the buyout price. If you don’t see the information there, contact the car dealership.

Next, evaluate the condition of the car. How much is your car really worth? Is it in good enough shape that buying it makes sense? Or does it have a lot of wear and tear or require repairs or expensive maintenance? Then, shop around to see if you can get a better price on the same car elsewhere. You may even be able to negotiate the price of your leased car with the dealership. This isn’t always an option, but it’s worth a try since you want to get the best rates for a lease buyout.

If you decide to go ahead with the purchase of the leased car, apply for financing if needed, and follow the process for purchasing the car.

Pros and Cons of Buying Out a Car Lease

Buying a leased car can sometimes make sense, but it’s not always the best option, depending on the purchase price and the condition of the car. Here are some advantages and disadvantages to consider before buying out a car lease.

Pros of Buying Out a Car Lease

One of the most obvious benefits of a lease buyout is that you already know the car’s history, which is something you likely won’t have when buying a used car (even if you get a used vehicle report, it won’t contain every detail).

If you’ve maintained your car meticulously and always kept it garaged, then you know that you would be purchasing a car that is in excellent condition.

On the flip side, if you haven’t cared for the car as well as you could have, a buyout can be an advantage as well.

That’s because most leases include extra fees for unusual wear and tear on a vehicle, which may show up during the inspection. Keeping the car can be a way to stave off that extra expense.

The same goes if you’ve put a lot of mileage on the car. If you’ve gone way over your lease’s mileage limits, a buyout can be more enticing because it allows you to avoid paying penalties for going over your lease’s limits.

Another potential plus to a buyout is that it can get you out of the lease cycle. When it comes to buying vs. leasing, purchasing a car may end up costing you less in the long run.

While buying typically involves higher monthly costs than leasing, you actually own something in the end. With leasing, you may have lower payments, but you can also get stuck in a cycle of never-ending car payments since you’ll never own the car free and clear. Creating a budget can help you see which option makes more financial sense for you.

Cons of Buying Out a Car Lease

One of the nice things about a lease is that you will always experience a relatively new vehicle every time you renew. For many drivers, the potential extra cost of perpetually leasing is worth that peace of mind.

If you opt to end the lease cycle and buy your car, one downside is that you’ll no longer be driving a new car. In determining the cost of ownership, you will likely also want to factor in the cost (and hassle) of car maintenance and repairs as the car gets older.

Your monthly expenses might also go up. If you buy out your lease and don’t make a new down payment, your monthly payments will likely be more expensive than your current lease payment. This is something to consider if you’re working to manage your money better.

Another potential downside to buying your leased car is that you may not be getting the best possible price for a used car.

When you get the option to buy a leased car, the vehicle is typically just a few years old and its residual value can be pretty high. It’s possible you could get a better deal by saving up for a car and buying a similar used vehicle on the open market.

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Is Buying Your Leased Car a Good Idea?

Before deciding whether to buy your leased car, you may want to compare the buyback price from your lease to the current resale value of the car.

The price of a lease buyout will be based on the car’s residual value, which is the purchase amount set at lease signing, based on the predicted value of the vehicle at the end of the lease.

You can often find this number — it may be called the “buyout amount”, “residual amount,” or “purchase option price” — on your lease contract. If you make your payment online, you may be able to find it by logging onto your account or by calling the bank that holds your lease.

Once you’ve got this number, you can use one of the many online car appraisal tools — such as Kelly Blue Book, Edmunds, or the National Automobile Dealers Association — to help you calculate the trade-in, buyback, and new car fair purchase price of your leased car.

To get the most reliable numbers, you’ll want to be as accurate as you can when you plug in the information about your car, including the manufacturer, options, and current condition.

If your buyout amount is considerably less than the average retail price, and you like the car, buying your car from the leasing company could indeed be a good deal.

Even if it looks like you would end up slightly overpaying, you may not want to dismiss the buyout option altogether.

Buying your leased car may still be a good idea if you’re going to get hit with pricey mileage charges when you return the car. This could end up making the buyout price a better deal than buying a similar used car on the open market.


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3 Tips for Getting a Good Price on a Car Lease Buyout

It can be tricky to try to haggle the price of a buyout, since dealerships typically don’t net a profit from selling you a leased car. But it makes sense to try negotiating for a better deal. These tips could help.

Opt for dealer financing

One technique that might motivate the dealer to help you is to agree to get your financing from the dealership. This could work to your financial benefit as well: Since dealers often have a number of lenders to choose from, they may also be able to get you a lower interest rate for the buyout loan than you might be able to get from your own bank or credit union.

Get a preapproved loan

It can still be a good idea to get a preapproved car loan from your bank or credit union before you go to the dealer so you know what rate you can qualify for. If you originally had a good credit score to lease a car in the first place, and you still do, that may help you get a more favorable rate.

Some people even work at building credit by leasing a car. If you made your lease payments on time and your credit strengthened in the process — again, that might work to your advantage in terms of rates you might qualify for.

Once you see what rate you can get for a car loan, you can then decide later if you want to go with the dealer’s financing for the car lease buyout.

Negotiate fees

If you can’t get a lower buyout price for the car, ask to have fees such as transaction or document fees waived or lowered. You can request an itemized list of buyout fees from the dealer and see if you can get them to bargain with you on some of them. If so, this could help you save money.

The Takeaway

Deciding what to do with your leased vehicle when the contract is up can require a little bit of research, and also some math.

It can be a good idea to compare the buyback price to what the car would go for on the open market. You may also want to factor in any additional charges, such as mileage fees, that could make buying out the lease more attractive.

Should you decide to buy the car (or to purchase a different car) and would need to take out a loan to do so, it can also be important to consider what kind of price, down payment, loan term, and interest rate you can afford. Then you can start putting away money in a savings account to buy out your lease, or purchase a different car.

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FAQ

Can you negotiate the buyout of a lease?

You may be able to negotiate the buyout of a car lease — it typically depends on where the lease contract originated. If it came from the finance department of the car manufacturer, you may not have much leeway. These finance departments are considered “captive lenders,” which means they likely won’t negotiate with you. If your car lease was written by a bank, however, you may have more flexibility for negotiation.

What is the downside to buying out a lease?

One disadvantage of buying out a lease is that you’ll no longer be driving a new car every few years. And once you own the car, it may cost more to maintain and repair it as it gets older.

In addition, if you buy out your lease and don’t make a new down payment, your monthly payments will likely be more expensive than your current lease payment.

Finally, by buying your leased car, you may not be getting the best possible price for a used car. You might be able to buy a similar used vehicle on the open market for a better price.

Is it smart to buy a car that you have leased?

It can sometimes be beneficial to buy a car you’ve leased. For instance, if the buyout price of the car is a lot less than the average retail price, buying out your car could be a good deal.

Also, if you’ve kept the car in excellent condition, it may make sense to buy out the lease rather than buying another used car and not knowing the true condition of the vehicle. Plus, you’ll actually own something in the end once the lease is paid off.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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