You will hear these terms and see some of them used in financial ratios, so it is important to understand how these types of shares differ.
First, let’s define the terms, and then I’ll explain why it is important to understand the difference.
- Authorized Shares – These shares represent the total number of shares of stock authorized when the company was created. Only a vote by the shareholders can increase this number of shares.
However, just because a company authorized a certain number of shares doesn’t mean it must issue all of them to the public. Most companies retain shares for use later called unissued stock or shares.
- Unissued Shares – Shares a company retains in its treasury and not issued to the public or to employees are unissued shares.
- Restricted Shares – Restricted shares refer to company stock used for employee incentive and compensation plans. Restricted stockowners need permission of the SEC to sell.
There is a waiting period after a company first goes public where insiders’ restricted stock is frozen. When insiders want to sell their stock, they must file a form with the SEC declaring their intention. Even insiders of established companies must file with the SEC before selling their restricted stock.
- Float Shares – Float refers to the number of shares actually available for trade on the open market. You and I can buy these shares.
- Outstanding Shares – Outstanding shares includes all the shares issued by the company, which would be the restricted shares plus the float.
Here’s a simple example with numbers to illustrate the relationship of these different shares:
- Authorized Shares – 100
- Unissued Shares – 20
- Restricted Shares – 10
- Float – 70 (100 – 20 – 10 = 70)
- Outstanding Shares – 80 (10 + 70 = 80)
Why is this Important?Here are several key bits of information you can determine from looking at how these different share types stack up in relation to each other:
- Look at the relationship of unissued shares and restricted shares to float for where controlling interest of the company will reside. Many companies retain a large percentage of the authorized shares in their treasuries or in the hands of management through restricted shares.
Companies do this to make sure no other company can seize control in an unfriendly takeover. They may also want to have stock handy for future issue instead of using debt to buy another company or for another major expenditure.
Controlling interest held in unissued stock means outside shareholders will have little influence over the decisions of the company.
- If the float of a company is very small and the stock attracts attention of investors it can become volatile because of supply and demand imbalances.
More buyers will drive the price up, which is not a bad thing if you own the stock. However, it may make the stock over priced relative to its earnings or other fundamental measures.
Likewise, if the stock falls out of favor, sellers may have trouble unloading their shares, which would tend to force the price down further and more rapidly than fundamentals might indicate.
- Watch what restricted shareholders do. You can get this information from a variety of online sources. Here is a link to MSN Money’s insider trading search function. Just enter a stock symbol and it will return the most recent sales or planned sales by insiders or major shareholders.
Most of the time, these sales signal nothing of interest to investors. When a large number of insiders, especially in young companies, file plans to sell major blocks of stock it could signal trouble.
- Notice when reading financial ratios whether they are using float or outstanding shares in the calculation. It can make a big difference in the outcome.