Share turnover is a crucial metric in the stock market, representing the liquidity of a company’s shares. It is calculated by dividing the total number of shares traded during a specific period by the average number of shares outstanding for the same period. A higher share turnover indicates that the company’s shares are more liquid.
Key Takeaways:
– Share turnover reflects market liquidity by dividing trading volume over outstanding supply for a given period.
– It does not indicate the quality of the stock or the reasons for its liquidity compared to other stocks.
– Share turnover should not be the primary criterion for investment decisions as it only considers quantity, not quality.
– Stocks with higher share turnover ratios are more liquid and easier to trade, while lower ratios suggest illiquidity.
– A higher share turnover may also suggest momentum, as trading activity can be driven by good or bad news, affecting the share turnover ratio for a given period.
Understanding Share Turnover:
The share turnover ratio indicates the ease with which shares of a particular stock can be sold on the market. It compares the number of shares that change hands during a period with the total number of shares available for trade. Investors may be hesitant to invest in companies with low share turnover due to the associated risks. However, share turnover is an interesting measure because it does not always correlate with expectations.
Investors often assume that smaller companies will have less share turnover due to their theoretical lower liquidity compared to larger companies. Yet, smaller companies often exhibit a greater portion of share turnover relative to their size. This can be attributed to pricing, as smaller companies typically have lower share prices, making the opportunity cost of buying and selling based on growth prospects smaller in terms of capital commitment. Companies sometimes split their stock to maintain affordability and liquidity.
Calculating the Share Turnover Ratio:
To compute a company’s share turnover ratio, you need the trading volume and the average number of shares outstanding. The formula is:
Share Turnover = Trading Volume / Average Shares Outstanding. The trading volume is the average number of shares traded in a given period, which can be obtained from exchanges or financial information websites.
The second number is the average shares outstanding. This refers to the total number of shares a company has issued. Note that this is not the total number of authorized shares. The number of shares outstanding is often less (but may be equal to) what a company is authorized to issue.
Interpreting Share Turnover: There is no set rule for what constitutes a healthy share turnover ratio as it varies by company and sector. Stocks with seasonality will see their share turnover ratios surge when demand for the stock is high. Companies with higher stock prices tend to have lower turnover as a single share is more expensive, reducing liquidity. This can make a stock seem less desirable. As a company performs better and its stock price rises, liquidity may fall. Another aspect of share turnover is defining an investor’s desired liquidity goal. During economic downturns, investors may want less liquid stocks. These can help preserve value during volatility as they can’t be traded as quickly. So, while most investors want liquid assets, stocks with lower share turnover may fit some investors’ goals. Example of Share Turnover: The share turnover ratio only tells how easily shares can be traded. It doesn’t indicate a company’s performance. For example, at the end of 2021, Apple had about 16.4 billion shares issued and outstanding. On Dec. 31, 2021, Apple’s 30-day average daily volume was 110.78 million shares. So, Apple’s share turnover ratio for December 2021 was 0.68%. At the end of 2021, Microsoft had 7.547 billion shares outstanding and a 30-day average daily volume of 28.31 million. Microsoft’s share turnover ratio was 0.38%. It might seem Apple’s stock performed nearly twice as well, but these percentages only measure liquidity. Limitations of Share Turnover: Share turnover has limitations. It doesn’t rely on financial performance. A stock can have a high turnover ratio but end at the same price. The share turnover ratio also doesn’t indicate a stock’s direction. For example, if government regulation stops U.S. citizens from buying gas-powered vehicles, shares of affected companies would likely fall as investors sell.As the stock is bought up at a significantly reduced price, the stock’s share turnover is likely to be high. However, a higher share turnover isn’t always better.
How is share turnover calculated? Share turnover is determined by dividing the average number of shares traded over a specific period by the average number of total outstanding shares for the same period. The resulting percentage represents the percentage of all available shares that could have been traded and were actually traded. Why is share turnover important? Share turnover indicates to investors the liquidity of the stock they hold. Some investors prefer knowing they can easily buy or sell a specific company’s stock. On the other hand, some investors may desire lower liquidity as it makes it harder for traders to sell their shares emotionally. Although share turnover doesn’t indicate stock price movement, it informs investors about the ease of selling their shares in the future. Is a low or high share turnover ratio better? Generally, a high share turnover ratio is beneficial if investors want to buy or sell securities easily. A high share turnover calculation means the stock is more liquid. If an investor is looking for stock that is more difficult to sell (to stabilize its value during emotional trading periods), then companies with low share turnover calculations are better. How can a company improve its share turnover ratio? A company can’t directly improve its share turnover ratio as it is a reflection of how the market interacts with its stock. If a company wants higher liquidity, it can take several steps. First, it can perform a stock split. Although this increases the number of shares outstanding and divides the stock price, making it more accessible for new investors to buy full shares. Second, a company can perform well. If a company improves its bottom line and performs extremely well, more investors will demand the stock, increasing the number of shares traded and share turnover. Correction—June 22, 2022: A previous version of this article misidentified Apple stock as illiquid.
