One of the more common mysteries of investing terminology is the varying forms of the basic unit of ownership in a corporation -- the share. We all love to own 'em -- now let's understand 'em.
The three share-related terms commonly encountered by investors are authorized shares, outstanding shares, and the float.
Authorized shares are the whole kit and caboodle -- the maximum number of shares of stock that a company may legally create under its Articles of Incorporation. Authorized shares can only be changed by shareholder approval. (And you thought your shareholder voice didn't count!) There are generally more authorized shares than any other type. By keeping the number of authorized shares higher than those actually issued, management can always sell more shares if they need to raise additional funds or make an acquisition. Those extra authorized but unissued shares also come in handy when employees exercise their stock options.
Outstanding shares are the number of shares of stock that have been issued. It includes restricted shares (insider holdings that can't be sold without SEC notification or are under some other kind of sales restriction) and shares held by the public (see float below). Outstanding shares are used in the calculation of things like market capitalization (price times shares outstanding), book value (usually expressed as a dollar amount per share), and the ever-popular EPS (earnings per share). This is the number that really matters.
The float is the number of shares floating around in public hands that are available for trading (or holding long term if you're a Fool). The formula for finding the float is: outstanding shares - restricted shares = float. But if you're mathematically challenged, a superior way to locate a company's float is by heading over to our quote area, typing in a ticker symbol, and clicking on Snapshot.
For example, look at the Snapshot for Foolish Four veteran Caterpillar. On the left side in the second grouping down, we see that Caterpillar has 351 million shares outstanding and the float is 305 million shares. Ta da! Easier than drinking an ice cream float (and a lot less fattening). This handy formula also gives you the number of shares held by insiders. Just subtract the float from shares outstanding. For Caterpillar, about 45 million shares are held by insiders. A relatively large float like this is typical of Foolish Four mega-companies. Smaller and younger companies may have a much higher percentage of insider holdings.
Many companies these days are engaging in share buybacks, which is often an indication that management sees the company as being undervalued. Share buybacks are beneficial to investors because their proportional ownership in the company is increased. Repurchased shares are subtracted from the number of shares outstanding, so each remaining share outstanding represents a slightly higher percentage of the company.
How do we account for shares that the company buys back?
When a company buys back shares, it's purchasing shares already outstanding. The corporation itself -- not the insiders -- buys the shares. This creates more value for shareholders, as the earnings per share are spread out over a smaller number. (The acquired shares are available for issuing a second time at a later date, at which point the shares outstanding and float will increase.)
To add one final element to the complete understanding of this whole share stuff, we must not forget warrants and stock options that control shares authorized but not yet issued. When warrants and stock options are exercised, the company must issue more shares to accommodate them. When a company issues additional shares, both the float and the outstanding shares increase, resulting in "dilution." Dilution results because the earnings per share are spread over a larger number of shares, thereby decreasing the value of all shares previously held.
When you see the term "fully diluted" earnings per share, the accountants have factored in not just the float and the restricted shares, but also the future shares that must be issued should the warrants and options be exercised. The reason we always look at earnings per share on a fully diluted basis is because sometimes there is a huge number of shares controlled by warrants and options. If that's the case, issuing those shares will cause dramatic dilution. All financial statements announce the earnings per share on a fully diluted basis as a matter of routine. That's the number to look for.
Mastering the language of investing is an ongoing process that takes years to accomplish. If you apply yourself, however, it will ultimately become as easy as do-re-mi.