Day Trading Encyclopedia
Stock Share Structure
Importance of Understanding a Stock’s Structure
One of the facets of trading that is often overlooked when performing fundamental and technical analysis is a company’s stock structure. A stock’s structure pertains to how the shares of a public corporation are set up. This can have implications on both a fundamental and technical level. Fundamentally, stock structures can affect earnings-per-share, voting rights, financing, dilution, valuation and short interest. From a technical analysis perspective, the stock structure can affect stock price behavior, the rigidity of price movement, spreads, volume, liquidity and momentum.
The outstanding shares represent the total number of authorized shares that are in the hands of shareholders, financiers, investors and insiders, which include free trading and restricted stock. The outstanding shares represents all authorized shares that are not held by the company, which are called treasury stock. Outstanding shares values tend to expand and contract based on actions by the company. Stock based compensation and private placements increase the outstanding shares, which can further dilute the shareholder value. Stock buyback programs will shrink outstanding shares, which technically increases the earnings-per-share (EPS) values without actually increasing the actual earnings amount.
This little trick is called financial engineering. For example, if a company has 10 million outstanding shares with $10 million in earnings, the EPS is $1 per share. If the company buys back 2 million shares leaving 8 million shares outstanding, the same $10 million earnings equates to $1.25 EPS and increase of 25% due solely to share buybacks, not an actual increase in profits.
The float is the total number of free trading shares that are in the hands of investors. These shares have no restrictions and can be traded any time. Shares held by insiders require reporting protocol and aren’t counted as part of the float until disposition, which also includes restricted shares, which cannot be traded until they meet certain time and vesting conditions. The float is usually much smaller than the total outstanding shares. Smaller floats equate to thinner liquidity since there are less free trading shares in the market. Smaller floats are also subject to more volatile price action and less daily trading volume. In many cases, smaller floats can lead to short squeezes.
When a company is incorporated, it is required to state the total number of authorized shares it can issue. The total authorized shares states the maximum shares that can be issues by the company. From that amount, the outstanding shares are derived from the shares it actually issues including the initial public offering, secondary offerings, private placements and stock-based compensation and incentives. Companies may authorize more shares, but it will further dilute the shareholder equity when they are issued.
Common stock is also known as free trading shares. These shares are offered to the public through an initial public offering (IPO) when a company decides to go public and trade on a stock exchange. Common shares carry voting rights but are the last in line to receive dividend payouts and have almost no claim on assets if the company has to liquidate assets in bankruptcy proceedings. Shareholders of common stock are invited to annual shareholder meetings where the company presents the annual report, which includes the audited financial statements, and reviews the company’s performance and strategy moving forward. Shareholders are also presented with various items for vote including executive compensation, dividend payments, auditors, pending mergers or acquisitions and board member changes.
Periodically, the company will release more shares into the market through equity offerings including secondary offerings, shelf offerings and private placements. Newly listed public companies also have lock-up expiration periods starting six months after the IPO, which allow insiders and restricted stockholders to sell their shares in the open markets. This tends to further dilute the float but improves liquidity. Shares tend to sell-off weeks before a lock-up expiration in anticipation of more shares flooding the market. Further lock-up expirations are scheduled by the company to incrementally increase the float. Successful lock-up expirations result in liquidity improvement, stock price stabilization and daily trading volume improvement as the market successfully absorbs the shares.
Preferred shares have priority on dividend payouts above common shares and have a claim on the company’s assets in the event of liquidation or insolvency. Preferred shares tend to receive higher dividend payments consistently since it act more like a bond and shares virtually the same rights as bondholders. Unlike common shares, preferred shares usually don’t provide voting rights. Many preferred shares have the ability to convert to common shares, also known as convertible debentures or preferred shares. Companies use preferred shares as a method of financing that doesn’t incur heavy debt.
Restricted stocks are non-trading company shares that cannot be transferred or sold until certain conditions are met. Restricted shares are commonly issued/granted to company employees and insiders as part of their compensation/incentive packages.
Companies have their own rules regarding vesting of employee stock and time requirements before restrictions can be lifted on shares. Restricted shares are also used to raise funds for the company through private placements, secondary offerings and convertible debt offerings. Restricted stock requires the company to lift the restricted status before the shares are available for free trading.