Share turnover measures a stock’s liquidity by comparing the number of shares traded over a specific period to the total number of shares outstanding. A higher share turnover suggests a more liquid stock, indicating it’s easier to buy or sell. It’s important to distinguish share turnover from a mutual fund or ETF turnover, which relates to how frequently assets are traded within the fund.
Key Takeaways
- Liquidity Indicator: Share turnover reflects a stock’s liquidity by dividing trading volume by shares outstanding over a set period.
- Non-Performance-Based: It indicates liquidity, not quality, and shouldn’t be a primary investment criterion.
- Market Sentiment: High share turnover can signal momentum; news events can drive temporary increases in share turnover.
- Investing Strategy: Stocks with high turnover are more liquid, while lower-turnover stocks may offer value stability for certain investors.
Understanding Share Turnover
The share turnover ratio reveals the ease with which investors can trade a stock on the open market. By comparing the number of shares traded within a period to the total available shares, it indicates liquidity. Investors might be cautious with low-turnover stocks due to potential challenges in buying or selling them. Interestingly, smaller companies sometimes exhibit higher share turnover because their shares are priced lower, attracting more frequent trading compared to pricier stocks from larger firms.
Calculating the Share Turnover Ratio
To determine a company’s share turnover ratio, you need two values:
- Trading Volume: Average number of shares traded over a specific period (available from exchanges and financial platforms).
- Average Shares Outstanding: Total number of shares a company has issued to date.
The formula is:
Interpreting Share Turnover
There’s no set benchmark for an ideal share turnover ratio, as it varies by industry and company size. High share prices generally result in lower share turnover since fewer investors buy large quantities of high-priced shares. During economic downturns, some investors even prefer stocks with lower turnover for stability, as they’re less likely to experience rapid price swings from trading activity.
For instance, during a volatile market period, illiquid assets might provide a buffer from emotional, quick trades, preserving value by being less accessible for immediate buying or selling.
Example of Share Turnover Calculation
Consider Apple and Microsoft at the end of 2021:
- Apple: 16.4 billion shares outstanding, 30-day average daily volume of 110.78 million shares.
- Microsoft: 7.547 billion shares outstanding, 30-day average daily volume of 28.31 million shares.
Apple’s turnover ratio is nearly twice Microsoft’s, but this doesn’t imply one stock outperformed the other. It simply shows that Apple’s stock traded more frequently relative to its outstanding shares.
Limitations of Share Turnover
While share turnover is a valuable liquidity metric, it has limitations:
- Non-Predictive: High turnover doesn’t guarantee price direction; liquidity doesn’t inherently suggest value changes.
- Not Performance-Linked: Share turnover doesn’t provide insights into a company’s underlying performance.
- Market Sentiment Effect: In cases of negative news, a high share turnover might reflect panic selling, temporarily boosting liquidity without any positive implications for long-term performance.
Share turnover provides insight into a stock’s liquidity without reflecting company performance. While higher turnover can signal ease of trade, it’s only one factor to consider in investing. A balanced portfolio may include both liquid stocks for flexibility and less-liquid stocks for stability during market fluctuations.
