The share turnover ratio isn’t the most important measure you have to take into consideration when picking a stock but it is important to know will you need a lot of time to sell off the stock.
Share turnover ratio shows how difficult or easy, is to buy or sell shares of some stock on the market. Share turnover ratio compares the number of shares traded during some period with the total volume of shares that available for trade during the given period. Investors often avoid the shares of a company with low share turnover.
Share turnover is a measure of stock liquidity. When we want to measure it we have to divide the total number of shares traded during the given period by the average number of shares available for sale. For example, if the 1 million shares are traded during the year, and the average volume of shares for sale was 100.000 then we can say that turnover was 10 times. Shares can have higher or lower turnover. The higher share turnover shows that the company has more liquid shares.
So, we can say that the share turnover compares the number of traded shares to the number of outstanding shares. When we see a high level of share turnover, this means investors can easier and smoother buy and sell the shares.
They often believe that smaller companies have less share turnover because they are, as investors think, less liquid than big companies. But that might be a great mistake. It isn’t rare that smaller companies have a greater amount of share turnover compared to big companies.
How is this possible?
Very often the reason is the price per share. Big company’s price per share can be several hundreds of dollars and only rich investors are buying them. Yes, large companies have huge floats, thousands of shares might trade daily. But what percentage do they have? The real percentage of their total outstanding shares is small.
On the other side, a small company’s share is significantly cheaper and such is traded more frequently. So, they may have a higher daily trading volume.
Possibilities of share turnover ratio
The share turnover ratio compares sellers versus buyers of stock. To calculate it we will need two numbers to know. One is the daily trading volume of stock and the other is the number of shares available for sale. This second number is actually a daily float of stock, the total number of outstanding shares. The result is expressed in percentages. And you will see, every time when we get as a result, the high share turnover ratio we can be sure that there is a high daily volume and low float. Also, a low daily volume and the high float will always give us, as a result, a low share turnover ratio.
But these figures are so relative. The real share turnover ratio depends on the company and the sector it belongs to. For example, you can see from time to time that some stocks have a high turnover ratio but it can be periodically. When the demand for some stock rises, the turnover ratio will grow at the same time. So, this ratio isn’t able to show how the company is healthy.
The limitations of share turnover ratio
The share turnover ratio can show how easy investors can buy or sell their shares of some stock. Literally, this ratio isn’t able to tell us anything about the company’s performance. Let’s assume you are examining a large company’s stock. You know that the company has, let’s say, 4 billion shares outstanding. It is a really large company. Also, the known fact for you is the averaged trading volume. It is, for example, 40 million per month. So, this company’s share turnover ratio is 1%. What does this number tell us? The stock is illiquid. Would you avoid this stock? Remember, it is a big, well-known company, with great history, with a permanent rise, good management, great prospect. Of course, you wouldn’t. Contrary, everyone would like to buy that stock. That is a case with Apple, for example. Would you avoid investing in that company? The point is that the low share turnover ratio shouldn’t be the most important concern when picking a stock.
Moreover, when a stock is dropping and only a few want to buy it, that stock will have low turnover. But the same is true if the stock is expensive. If single share costs, for example, $800 only a small number of investors can afford to buy it and the share turnover ratio will be very low.
So, do you understand why this ratio isn’t reliable when you want to estimate how good stock is? That is the reason why you should use the other parameters too.
Is this measure important at all?
In short, yes.
It is an important measure and investors should be aware of it. A low share turnover ratio indicates that you may need a lot of time to sell off such stock and, what is also important, the stock price may decrease while you are waiting to find someone and sell it. Hence, not many investors are willing to put their money as such a risk and buy the share of the company with a low share turnover ratio. But always keep in mind, a low share turnover ratio is normal for a small market-cap company. But we owe you an explanation of what is an average daily trading volume.
Average daily trading volume
Average daily trading volume or short ADTV is the average number of shares traded during one day in a particular stock. Daily volume simply means how many shares are traded per day. So, we can average daily volume. It is a crucial measure because high or low trading volume triggers different kinds of traders and investors. Some investors and traders favor high average daily trading volume. It is because with high volume is easier to get into and out of the position. As we already said, when the stock has low volume it is more likely to be harder to enter or exit at the proper price since there are less buyers and sellers. But when the traders and investors start to value the stock differently ADTV can increase or decrease. For example, if the average daily trading volume is higher, that means the stock is less volatile and more investors would like to buy it. But this doesn’t mean that stocks with high volume don’t change in price because they can change a lot.
The higher the trading volume is, the more buyers and sellers will easier and faster execute a trade.
This is a useful tool for analyzing the price action of any liquid stock. For example, the increasing volume may confirm the breakout. If there is any lack of volume, the breakout may fail. But that is the subject for a longer article.
Several figures and ratios deliver information about stocks and represent great help to investors when deciding whether they should buy or sell. The stock volume and the share turnover ratio are one of them. They provide valuable information about any stock.
Share turnover ratio is an important measure for investors but shouldn’t be used as a sole criterion. If investors or traders use this one solely it is more likely they will miss out on very important data, for example about the quality of the stock, and make a wrong investing decision.