Definition of Stock Turnover and Examples
Stock turnover measures the liquidity of a stock, or how quickly it can be sold in the open market. Stock turnover refers to the liquidity of a particular share. Specifically, it measures how easy or difficult it is to sell shares in the open market by comparing the total number of issued shares to the number of shares traded over a certain period of time.
How to Calculate Stock Turnover
To measure the stock turnover of a company, you need two numbers:
Trading volume: The total number of shares traded over a specified period
Number of issued shares: The number of shares the company has issued
Then you divide the total number of shares traded during the period by the number of issued shares. This calculation is represented by the following formula, where Tn is the total number of shares traded (trading volume) during a timeframe, and So is the number of issued shares:
Number of shares traded / Number of issued shares = Stock Turnover Ratio
You can also calculate the stock turnover ratio that shows the volume of shares traded as a percentage of total listed shares during a specified period. Using the example above, the number of shares traded (Tn) would be 20% of the total number of issued shares (So).
How Does Stock Turnover Work?
A high stock turnover ratio indicates that it will be easy for you to buy and sell shares because there may be more shares being traded. Conversely, a low stock turnover ratio indicates that buying or selling shares may be difficult.
Apart from measuring liquidity, there’s no way to evaluate what constitutes a “good” or “bad” stock turnover. Hatch Asho, founder and CEO of Pillar Wealth Management, said in an email to The Balance: “There are no specific benchmarks for what constitutes a good stock turnover ratio as it varies from company to company and from industry to industry.”
Moreover, stock turnover is not a broader indicator of the value of a stock. Asho stated: “The stock turnover ratio only indicates how easy it is to sell a stock for the investor. It does not necessarily reflect the performance of the company behind the stock.” Superior performance may even lead to lower stock turnover, making it difficult to sell shares. Asho said: “When the stock price falls, and no one wants to acquire it, low turnover is common. However, if the stock price rises to the point where one share costs hundreds of dollars, the number of people who can participate will be limited. When viewed exclusively through the lens of stock turnover, it appears that these two very different events are similar.”
Improving Stock Turnover
There are several ways a company can improve its stock turnover. Smaller companies may move from regional exchanges to larger exchanges to increase stock turnover because larger exchanges broaden the base of investors.
When stock prices are too high, a company may conduct a stock split. This reduces the price per share, making the company’s stock more accessible to budget-conscious investors.
What Does This Mean for Individual Investors?
Alone, stock turnover does not provide a sufficient picture to evaluate whether a stock is a worthy investment. Asho stated: “[Stock turnover] doesn’t say anything about the quality of the stock or why it might be more or less liquid than other stocks for the currently measured period.” As it measures quantity rather than quality, stock turnover should not be used as a key investment criterion.
Investors should consider other factors in addition to stock turnover, such as the price-to-earnings ratio, to make informed investment decisions.
Key Takeaways
- Stock turnover refers to the liquidity of a particular share – specifically, how easy or difficult it is to sell shares in the open market.
- To calculate
- Share turnover should be calculated by dividing the total number of shares traded by the number of issued shares.
- A high share turnover ratio indicates that it will be easy for you to buy and sell shares, while a low share turnover indicates that buying or selling shares may be difficult.
- There is no way to evaluate “good” or “bad” share turnover, and share turnover does not indicate the stock’s value or the company’s performance.
- Companies can improve share turnover by moving to larger exchanges or by conducting stock splits.
- Share turnover alone does not provide a sufficient picture to evaluate a stock investment, and other factors should be considered, such as the price-to-earnings ratio.
Source: https://www.thebalancemoney.com/what-is-share-turnover-5208807
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