Investing in the stock market can be a daunting task, especially for beginners who are unfamiliar with the various terminologies used in the industry. One important concept that investors must understand is the different definitions of shares.
As an investor myself who specialises in value investing, it is essential to have a comprehensive understanding of these definitions to help guide my investment decisions. In this blog post, we will discuss outstanding shares, floating shares, basic shares, diluted shares, treasury shares, and authorised shares.
Outstanding Shares
Outstanding shares refer to the number of a company's shares that are publicly available for investors to trade on the secondary market. This includes restricted shares held by insiders and equity held by institutional investors such as mutual funds and pension funds. The number of outstanding shares can increase if the company issues new shares or if employees exercise stock options. Conversely, the number of outstanding shares will decrease if the company buys back its shares.
For example, let's say a company has 100 million outstanding shares, and it decides to issue 10 million new shares. The number of outstanding shares will increase to 110 million.
Floating Shares
Floating shares are the outstanding shares minus closely-held shares which are shares that are held by a small group of controlling shareholders, such as directors of the company. However, they must be actual shares. Floating shares represent the active shares available for trading in the market and exclude groups holding significant portions of equity. Many indexes use the floating shares of a company to calculate its market capitalisation.
For instance, let's assume a company has 100 million outstanding shares, out of which 10 million shares are closely held. The floating shares will be 90 million. The floating shares are the ones available to the public for trading and investing.
Basic Shares
The total amount of shares outstanding can be calculated as either basic or fully diluted. The basic number of shares outstanding represents the current number of shares that are readily available on the secondary market. They are shares held by all shareholders. For instance, if a company has issued 100 million shares, and 90 million of those shares are currently being traded in the market, the basic shares will be 90 million.
Diluted Shares
Fully diluted shares outstanding refers to the total number of shares that a company could have if all the dilutive securities that could potentially dilute the value of existing shares were to convert into shares.
Dilutive securities include options, warrants, convertible debt, and even stock-based compensation. Stock-based compensation is a way to incentivise and reward employees, but granting stock increases the number of shares outstanding and leads to dilution. Dilution from employee stock is one of the biggest causes of dilution to shares outstanding.
For example, let's say a company has 100 million outstanding shares and also has 10 million outstanding stock options. If all these stock options are exercised, the fully diluted shares will be 110 million.
Treasury Shares
Treasury shares are shares that a company has bought back, which reduces the number of outstanding shares in the market. The company holds these shares itself and cannot be sold in the open market. Treasury shares plus outstanding shares make up the total number of issued shares. Treasury shares can be retired, which permanently cancels them, or held for resale in the open market. Non-retired treasury shares can be reissued through stock dividends, employee compensation, or capital raising.
For instance, if a company has bought back 10 million shares out of the 100 million outstanding shares, then the treasury shares will be 10 million. The outstanding shares will be 90 million, and the issued shares will be 100 million.
Authorised Shares
Authorised shares refer to the maximum number of shares a company can legally issue to investors. The number of outstanding shares can either be equal to or less than the authorised shares. For instance, a company may authorise 100 million shares for an IPO but may only issue 80 million of those shares.
Authorised shares give companies flexibility in raising capital. Companies can issue new shares to raise funds for growth, acquisitions, or debt repayment. However, issuing too many shares can lead to dilution and a decrease in the value of existing shares.
Conclusion
Although it can be confusing, understanding the different definitions of shares is important for making informed investment decisions as it can influence financial ratios like EPS and market capitalisation. For example, when calculating earnings-per-share (EPS), you can use either diluted or basic shares but the outcome is significantly different. Therefore, investors should consider the impact of outstanding, floating, basic, diluted, treasury and authorised shares on financial ratios when making investment decisions.
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