Once you've narrowed your potential investment opportunities through technical and fundamental analysis, you must determine the stock's current share structure. The share structure determines how the stock will move with buying and selling pressure, and how the market values the company. Share structure components affect stocks in various ways, and we offer guidelines to separate the wheat from the chaff.
Share structure informs you about the amounts and types of stock the company has issued: the number of outstanding shares (shares in public hands) and the float (number of shares available on the market). These two factors have the biggest effect on how a stock will trade and how high it may rise.
Outstanding shares represent the total number of shares issued by the company, including free trading and restricted stock. The float consists of all the outstanding (unrestricted) shares available for exchange between traders and investors on the open market.
The Float Effect
The current stock float represents the number one factor that determines how a stock will react to buying and selling pressure. An ideal stock should have a lower number of outstanding shares and a lower float. With tons of shares available, ordinary shareholders and market-makers will be able to sell these shares while the price slowly rises. With a low float, buying pressure forces the prices up to levels at which stockholders want to sell.
However, with a low float (not enough shares available), you may encounter problems purchasing the shares without chasing the ask price. The more money you try to invest, the harder you need to chase. It's also often difficult to sell your shares once you have them unless there are enough buyers or you sell your shares with a discount from the current price. That's why low float stocks can move huge percentages in a short time. You should trade low float stocks only after you've acquired some trading experience.
Beginners should trade stocks with a medium number of outstanding shares and a medium float. For penny stocks, this generally equates to a count of around 100 million to 500 million outstanding shares and a float between 50 and 90% of the outstanding shares. This variation should be based on the stock price. With a higher price per share, you can easily trade stocks with a lower number of outstanding shares.
Restricted Shares
The presence of restricted shares indicates a company in good standing. Companies often issue restricted shares to others as payment for services (including consulting, accounting and legal), and company insiders may also hold restricted shares. If management accepts restricted shares as compensation, you may assume that it's in its best interest to see the stock do well. Beware when shares go unrestricted (usually after one year), as shareholders may dump and cash their shares. It's always a good sign when management holds shares past the restriction period. Investors should always try to find out who holds the company's restricted shares by contacting the transfer agent.
Authorized Share Count
In addition to the outstanding shares and float, we also talk about the authorized share count, which is the current authorized maximum amount of shares that the company can introduce into the market. This number may signal an upcoming dilution and traders might refuse to buy these shares if the number of authorized shares tops the number of outstanding shares. However, Pink Sheets and OTC companies can increase their authorized shares on very short notice.
Contact the company or its transfer agent on a regular basis to confirm that the share structure hasn't increased. Regularly gathering any and all information can give you an advantage when it comes to selling your position before you lose money. If you plan to invest in a company with a gagged transfer agent, you won't be able to find out changes to the authorized shares, outstanding shares or float. Don't play a stock with a gagged transfer agent for more than a quick trade.
