Outstanding Shares

Okay, first things first: this is not a qualitative assessment of shares. Shares may be bad, awful, mediocre, good, or even outstanding, but that’s not what this term refers to.

It also doesn’t mean that they’re, uh...out standing in the rain. Rather, it is a technical term that reflects how many pieces make up the sum total of the ownership pie of a company.

Baby’sFirstChainsaw.com has 40 million slices and is currently trading for $15 a slice. Wow. Who knew toddlers were so into mechanical power tools? Or how sick and twisted the writers at Shmoop are? Anyway, if you didn’t catch the cleverness here, a slice equals a share. So the company has 40 million shares outstanding.They are trading at 15 bucks each. And that gives the company a market value of 600 million dollars.

That means that if someone wanted to buy the entire pie, they could, in theory, pay 600 million bucks, assuming everyone would sell to them for 15.

Can the shares outstanding change? Sure. Various factors change that number all the time. When an employee decides to either buy out or sell the stock options granted to her when she joined the company, those options convert into shares.

So if she had 10,000 options and sold them, the company would then have 10,000 fewer options outstanding, but would now have 40,010,000 shares outstanding. The options just converted into shares. Amen.

Okay...what if the company wanted to raise 30 million bucks to buy a small competitor for cash? It could sell to the public 2 million shares at 15 bucks a pop. Did it already own those shares? Likely not. So it had to print them out of thin air (ta-da!) and then sell them to new buyers. Add 2 million to the total, and now the company has 42,010,000 shares outstanding. It also has 30 million bucks more in cash on its balance sheet, by the way.

Now, there’s a danger in the increase in shares outstanding. It’s called share creep, and it refers to the gradual increase in shares outstanding. Because now, instead of a 600 million valuation with 40 million shares at 15 bucks, the company (if it were to still have a $600 million valuation) would see its stock price drop to $600 million divided by 42,010,000, or $14.28 a share. So in the process of the options being converted and the cash being raised, the company “destroyed” 72 cents a share in value.

What we’re omitting here is that the company raised 30 million of cash in this process…cash that we investors presume it will use wisely. And not on, you know…kibble for the office terrier.