This question comes from Nitin in Elk Grove, CA:
I recently read your book and am researching potential Rule #1 companies. My question is regarding the importance of institutional ownership. I seem to recall that somewhere you recommend looking only at stocks that have 60% or more institutional ownership. Does that mean that I should exclude the others from analysis? Some stocks like INFY that otherwise look pretty good have low institutional ownership (I think only 11% for INFY).
My response:
First, let's get everybody on the same page. On MSN Money put in INFY and on the left menu click on 'ownership'. Notice where it reads "Ownership Information" it says shares outstanding are 554 million. And right below that it says "Institutional Ownership" 11.40.
But notice that below that it also says "Mutual Fund Ownership" 33.01. I consider all these guys "institutional". They, as a group, are the 'Big Guys' I write and speak about. So the Big Guys own 44% of INFY. (For MSN 'Institutions' are non-mutual fund Big Guys.)
We want institutional ownership because of two things:
- They won't buy and sell a stock unless it has enough liquidity to get in and out of big positions, so when they are holding a bunch of a stock it tells us that it's a fairly liquid investment.
- Because they are so large, they have to move slower than a small investor when they buy a 5% position, for example. And slower when they sell it.
What they do is move small numbers of shares a whole bunch of times. For example, a mutual fund manager who sells off 7 million shares of YHOO will sell the shares in 500 share chunks. Do the math. That's about 14,000 separate trades that will be executed by his broker to get the sale done.
YHOO averages about 30 million shares traded each day, which is, at 500 shares per trade, about 60,000 trades a day. If a seller dumps 25% of the day's trading at once, goodbye price. So they spread it out. That process makes for more orderly pricing up and down and means that we can count on the Big Guys taking some time to change their position. Which means the Tools have time to pick up the change and we have time to exit or enter with the Big Guys. That's good for us.
How much Big Guy money is necessary? About 25% or more is good enough because MSN can't track other big guy money -- like insurance funds, companies like Berkshire Hathaway and so on. So if 25% is owned by what MSN is calling the Big Guys, then the actual percentage is higher and we're happy.
Now go play.
Phil
