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'Shares Outstanding' Reveals More About A Company's Future Than You'd Ever Think

Each week, one of our investing experts answers a reader's question in our InvestingAnswers' Q&A column. It's all part of our mission to help consumers build and protect their wealth through education.

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Q. "I just bought my first share of stock -- Apple, since I love all of their products. However, I was wondering something: Do all companies have the same amount of shares available to buy? How does that work?" -- Jean, Oakland, Calif.
 
This week's question will be answered by InvestingAnswers investment analyst David Sterman:
 
A. Jean, you've hit upon a very important topic that few investors fully grasp when they are starting out. Indeed, the amount of shares a company has issued, both now and in the future, can make the difference between a winning and losing investment. Let me explain.
 
When a company incorporates and lines up investors, it creates an ownership structure that is broken down into individual shares. Of course, some shares need to be set aside for investors so cash can be raised to make the necessary investments for future growth. And when a company finally steps up to go public with an Initial Public Offering (IPO), more shares are sold to an even larger group of investors.
 
Over the course of time, many companies issue yet more shares as they seek to:
  • Reward employees and management with shares.
  • Raise more funds through the sale of more shares.
  • Split a stock so it is more reasonably priced and can attract new investors. (The amount a stock is split, whether it's 2-for-1 or 3-for-1, means the number of shares must be increased by a commensurate amount, i.e. 100% or 200% in this example).
Some companies have issued just a few thousand shares. Apple, to use your example, has a stunning 934 million shares in circulation.
 
Of course, some companies reward investors by actually shrinking the share count. Companies often announce "stock buyback" plans, which means that their representatives in the financial services industry acquire shares from other investors and simply retire them. Such moves can really pay off.
 
[InvestingAnswers Feature: What Stock Buybacks Mean to Investors]
 
Take Home Depot (NYSE: HD) as an example. Back in January 2004, the do-it-yourself home improvement retailer had 2.3 billion shares in circulation. At the time, Home Depot had nearly $3 billion in cash and didn't need the money to run the business, as operations were already profitable. So in the intervening years, Home Depot bought back (and retired) more than 700 million shares. And by reducing shares outstanding by more than 30%, the company's earnings per share have been able to rise steadily higher.
 
Analysts believe Home Depot will earn a company record $3 in earnings per share (EPS) in fiscal (January) 2013 and close to $3.50 a share in fiscal 2014. Had Home Depot not bought back all those shares, then EPS would have been far lower. And at the end of the day, a stock's value is tied to the amount of EPS a company can generate.
 
The Investing Answer: The amount of shares outstanding is one of the more overlooked aspects of investing. Investors often pay attention to a share price and a company's profit or sales growth but they may not always notice if the amount of shares is growing at a rapid pace. A fast-rising share count can sharply dilute the value of all other shareholders' stakes in a company, so be sure to keep an eye on the share count on a quarterly basis while you own a particular company. As the Home Depot example shows, stock buybacks can help boost the value of a stock as the number of shares in circulation fall.

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