Saturday, February 20, 2010

Shares Outstanding and Float

When doing some research on a company whose stock I intend to buy I came across the number of Shares Outstanding and also another concept referred to as the “float”. What do these numbers represent?

Ownership of a public company comes in the form of shares of stock which determine the owners of the equity in a company and the size of their stake. The number of shares outstanding represents the total number of shares of stock that have been issued by a company and therefore this number includes 100% of the ownership of the company. If a company has 1000 shares outstanding and you own 40 shares, then you are the owner of 4% of the company.

Out of all the shares that are outstanding for a company, sometimes only a portion of the total are actually trading in the market. There are many reasons why not all the outstanding shares may be trading in the market. The most common ones are large stakes that have been owned by the original founders (or maybe their heirs) and who want to retain them and also restricted stock which represent shares that have been issued but that can not be freely bought and sold as they have certain restrictions (typically when stock is used as a portion or total of an insider’s salary or bonus). The total number of shares that are available for trading in the market is called the float.

The reason why it is important to know the float of the stock you want to buy is because in many cases it determines its volatility.

Stock prices are set via an auction-like process where supply and demand are allowed to find an equilibrium price between buyers and sellers. If the supply is greater than the demand (more sellers than buyers) the stock price will fall until it reaches an equilibrium price between buyers and sellers and vice-versa when demand is greater than supply (more buyers than sellers, causing the stock price to rise).

Daily trading volume is the number of shares that changed hands during a day. If the demand for the stock of a company is very large then its price will increase until sellers are willing to part with the stock they own. If the float is small (relative to its daily trading volume), then prices are going to have to rise rapidly because the demand for stock will not be met with willing sellers (since the float is small) and new sellers (current owners of stock) will have to be brought on by bidding higher and higher prices. If the float is large, on the other hand, the same demand will more likely be met with willing sellers (since there are more shares that are trading in the market) and so the price will likely not have to rise by the same amount as is the case with a smaller float. In summary, a stock with a small float (especially relative to daily trading volume) will mean that its price will be more volatile than a similar stock with a larger float. As traders we need to be aware of this when we design our trading strategy.

As an example, let’s look at a company called Xenoport (ticker: XNPT). Xenoport is a Biotechnology company trading on the NASDAQ. The number of shares outstanding for XNPT is 30.34 Million shares with a float of 27.89 Million shares. This means that 2.45 Million shares are outstanding (i.e. have been issued) and are not available for trading. On February 18th, XNPT traded 36.5 Million shares, moving its price from $19.60 to $6.67 (down around 66%, or a change in Market Capitalization from $594 M to $202 M) on news that the FDA decided not to approve one of its developmental drugs. As you can see, with a float of 27.89 Million shares and with 36.5 Million shares traded in one day that means that more than the entire float was bought and sold (with clear selling pressure) on that day alone and that might explain the magnitude of the move.