Companies often report several different share counts -- authorized and outstanding shares are two that are commonly reported -- which can make it difficult to understand which is most relevant for investors. Knowing the difference between authorized and outstanding shares is important when calculating something as simple as a P/E ratio, which requires that you use the correct share count to determine earnings per share.
Here's the simple explanation of how authorized and outstanding shares differ from one another.
A limit on a company's share count
Authorized shares are simply the number of shares that a company is authorized to issue by its shareholders or board of directors, depending on who has the authority to approve the limitation. You can usually find the number of shares authorized on a company's balance sheet.
Many companies, especially public companies, have massive authorized share counts. Costco, for example, has authorization to issue 900 million shares of common stock in addition to 100 million shares of preferred stock.
Think of authorized shares as a weak "cap" on the number of shares that a company can issue, since this number can usually be increased or decreased by a vote of its shareholders or corporate board. Most commonly, a company's authorized share count is increased to account for a stock split in which one share of stock is divided into two or three new shares of stock, for example.
The shares that really matter for investors
What really matters for investors is how many shares of a company's stock are outstanding. Outstanding shares are shares over which ownership and earnings of the company are divided.
Let's go back to Costco. It had authorization for 900 million shares of common stock at the end of its 2015 fiscal year. However, at the same time, it had fewer than 438 million shares outstanding, less than half of the shares it is authorized to issue. For investors, the 438 million shares outstanding is the much more relevant figure.
The number of outstanding shares can vary from quarter to quarter, and year to year. Some companies issue shares to raise additional capital, or to pay management, increasing shares outstanding. Others repurchase shares to reduce their shares outstanding and increase the fractional ownership of each remaining share.
In short, authorized shares are how many shares of stock a company could theoretically issue. Outstanding shares are shares over which ownership and earnings are divided, and on which dividends are paid, making a company's outstanding share count the most relevant figure for investors.
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