SPX Shares Outstanding

Below is a graph of the SP500 supply of stock. The preface to this graph is that the information presented in this graph was obtained from free sources on the web and therefore it should be noted that the actual issue date of stock is different from the reporting date. So to be precise, this graph shows you the supply as reported rather than when the supply was issued. This introduces a lag of 1 to 12 weeks which is beyond our control due to the fact that SEC filings are the source of this information. This of course affects the direct correlation and therefore invalidates the use of other statistical measures. However this graph does show an interesting relationship which defies the basic rules of supply and demand. This was unanticipated. But if a cynic were to view this, perhaps this rationalization would result...

May 2003, Congress lifts double taxation on dividends. Investors regain interest in buying stock. Companies increase stock repurchase plans.

The government has given investors a reason to return to the stock market but "Wall Street" increases supply unbeknownst to investors. This increased supply of stock will weigh on prices once investor demand cools but a floor in prices will result because of company repurchase plans.

Perhaps someone with more resources would share with us and the investment community at large a "real-time" graph of supply and prices. But until someone does, find out about the supply of stock in your investments and track the changes in their supply.

In economics 101, the concept of supply and demand is illustrated and explained, but where on the web is "Wall Street" presented in these terms? Many reports attempt to explain the economy's growth and strength and many reports simply relay information regarding the actions of many public companies and the actions of our government that drive our economy, but a measure of the supply of stock isn't one of these reports that ever reaches investors. The basic tenets of economics won't be explained here, but as an investor you should wonder why is it that "Wall Street" doesn't publish along with prices and volume, a daily summary of the supply of stock available on the exchange (the shares outstanding) and more importantly the amount of shares that investors are able to trade (the float)? A simple concise report that highlights the changes in the supply would be even better. But these reports aren't available. As an investor you should wonder how has the supply of stock changed and what were the reasons for the changes in supply? Plus, you should be concerned about future company stock sales because every time a company sells stock, it's a chance to dilute the value of your investment. In addition, you should ask why did the company need to spend your money (presuming you own shares in the company) to refinance? Remember these transactions cost millions of dollars, so ask why was it necessary?

Generally, technical analysis analyzes prices and volume. Using economic terms, this is the demand side of the equation. All those indicators in some way transform prices into another visual representation so that you can see patterns. Finding patterns is so intoxicating that an enormous amount of time, money, and effort has been spent on understanding the demand side of the equation, but when was the last time you saw a graph of the supply side of the equation or saw a reference to supply?

Below is a chart that shows you how the supply of stock in the SP500 has changed as of 5/12/03 and these figures are updated on a weekly basis. The number of shares outstanding as reported on 5/12/03 was 287.413 Billion shares and the float was 264.676 Billion. Since then the graph shows the cumulative changes in the number of shares outstanding and the float and compares that to the closing price of the SP500 (SPX). So the supply of stock has increased from 5/12/03 to 8/1/03 by 0.934 Billion shares and the float increased by 1.5 Billion shares. This means that the SP500 has increased the supply of stock by 0.57%. That 1.5 Billion share increase is less than 1 percent of the total shares outstanding. In addition, this means that the shares available to investors has been increasing at a faster rate than the overall supply of stock. So as an investor ask yourself why would that occur?

The fast answer is because increasing the number of shares available for trading is now self-serving. Companies now have an incentive to pay dividends and it is in the companies interest to own as much of its own stock as possible. Remember that if a company declares a dividend and pays a dividend all shareholders receive the dividend. So if the company owns 100 Million shares, it too receives a dividend check for those 100 Million shares.

This isn't intuitive, so let's review a little history and a few tax facts. Back in the early 1900's an investor ask two questions: 1.why should I give you my money? and 2. what's in it for me? Back then stock prices didn't move that much and buying into a company was a big deal. So an investor had to two ways to make money from their investment (still the same two avenues today): 1. dividends, and 2. rising stock prices. Essentially, investors were more impatient that we are today and the investor demanded a revenue stream from their investment and so the company paid them a dividend. Basically, an investor relied on dividends to earn a return on their investment and so nearly all companies paid a dividend. A company that didn't pay a dividend was extremely rare because from the investor's point of view it didn't make sense to invest in that kind of company. Now fast forward to the 1990s. Most companies now don't pay a dividend and the reason for this transformation is because it is inefficient. As always, the government mucked it up.

Remember that as an investor you still evaluate your investment based on two earnings streams: 1. dividends and 2. stock price appreciation. Well, if one of these earnings streams is taxed twice wouldn't you try to avoid "double taxation"? Well, that's what happened; so companies stopped paying dividends. However, this aversion to paying dividends then gave companies more money to spend. Remember, if they're making a profit and they're not sharing it with you, the investor, then the officers are going to spend it in other ways. This lead to the excesses we are seeing in the news: companies buying other companies at exorbitant prices; extravagant office complexes with lavish furnishings; huge salaries; outrageous perks and benefits; and stock options. These all come at the shareholders expense and let's not forget that the officers of these companies are only human. Some executives stretched the rules and some even broke the law, but these transgressions arose from the "shell game" of hiding the money from the government. The government created a tax inefficiency and Corporate America exploited it.

Up until this year (May 2003) Congress was taxing the dividend twice. This occurred because the govenment taxes both corporations and individuals. Remember that when a company pays a dividend it is paying out profits to its shareholders. But these pay-outs are after taxes. So you, as part owner in the company and investor, are sent a profit-sharing check. Now you file your personal income tax return but the government defines dividends as income so you pay income tax again on those profits you received from your company after the company already paid taxes for those profits. This is double taxation.

Recently in May 2003, Congress enacted a law declaring that taxes on dividends would now be reduced to the same tax rate as captial gains which is now 15%. This reclassification of dividends is important because dividends are no longer taxed at the higher personal income tax rate which currently has a maximum of 38.6%. However, for those of you thinking of trading stocks short term to collect dividends - don't. Congress has added the condition of holding the stock for 60 days for that dividend to qualify for the lower tax rate. In addition, individuals that receive dividend checks can now reduce their adjusted gross income and hence lower their income tax. This now removes what once was a market inefficiency and allows companies to distribute their profits more directly to shareholders. Now a company doesn't need to avoid the dividend option to distribute its profits to their investors/shareholders and therefore stock prices aren't the only way to reward investors. Now when a company sends a check, that money is taxed at a lower rate to the investor and presumably now available for further investment or spending. In either case, the investor can now receive a little now instead of waiting to sell stock later. As an investor this is great because now you aren't penalized for receiving checks from your investments. But there are ramifications.

One ramification is that the government just lost another source of income, but we have to ask did it really lose all that much? The reason we question this loss of income is because much of the late 1990s stock market rally is do in part because companies weren't paying dividends to investors. So the only avenue for investors to receive their return was through price appreciation. And when an investor sold their investment, the government taxed it. So in the end the government grabbed its share and hence no revenue was lost. Now, politicians don't see it that way, but investors do. What the government lost was the amount of tax resulting from double taxation, but this didn't amount to much since most companies don't issue a dividend. Of course this is relative to amount of tax the government receives from taxing capital appreciation.

The second ramification is that more investors will be receiving dividend checks which will increase their expendable income. An investor's wealth will no longer be a simple function of stock prices. They won't be as rich on paper but they will have more money to spend now. This will help offset any decreases in wages or reductions in the growth of future pay raises, but it won't be a substitute for the loss of a job. Investors will have more money to spend now instead of calculating their wealth on paper.

The third ramification is that it appears as though companies are unduly paying their employees twice. However, this view is wrong. It was a shame to hear reports that Bill Gates would be earning an additional several hundred million a year when Microsoft declared a dividend for the first time. This was probably precisely why the company never voted to pay-out dividends in the first place because it looks like he is voting to pay him self more money. Although this may seem inappropriate, it isn't. What was truly inappropriate was that investors had to forfeit the dividend earnings stream and rely solely on price appreciation for investing in Microsoft. The fact that the founder of the company is still there and that he didn't sell his shares is his business. The fact that the founders were able to retain a hefty portion of the company's equity or a large number of shares is a direct result of the supply problem. Since the company didn't pay dividends the only way for the company to repay its investors was through higher stock prices. But as stock prices rose investors held on to their shares which necessiated the offering of more stock. So over the years Microsoft split 9 times and turned one share into 288 shares. Their are now 10 Billion shares of Microsoft outstanding largely due to do to the fact that investors are holding on to their shares.

Now Microsoft has changed the rules. It will be sharing is profits with investors by sending them a dividend check. So the earnings (cash generated) that were once plowed back into the company are now being sucked out of the company and distributed to its shareholders/investors. This new company policy certainly has an impact on future stock prices.

The fourth ramification is that companies benefit from owning their own stock. They too will be able to receive dividend checks and gain immediate access to cash which presumably would be used for reinvestment. Before when the company didn't pay-out dividends the profits were plowed back into the company but the incentive was to pay as little in taxes as possible. So the goal was to spend as much as possible. This gave companies the impetus to become creative with their money. Some companies bought other companies causing the merger mania that ensued during the 1990s. Some companies just blatantly wasted their profits by spending it lavishly on their board members in the form of fantastic salaries, bonuses, and other extravagant perks. In the end, the removal of dividends as an earnings stream to investors promoted another market inefficiency - wasteful indulgence. Now that companies are beginning to share profits with investors, companies will be competing for investors. This will drive out wasteful indulgence and foster an enviroment where conservative management is rewarded with higher stock prices as investors flock to companies that pay out more and pay more attention to the bottom line. Hype is out; results are in.

Fifth is that companies stock prices will not appreciate as quickly. If companies are distributing a portion of their profits to shareholders/investors now, then the stock price will reflect in some measure a proportion of future disbursements which is similar to valuing an annuity. And if the company is rewarding the investor today, by taking profits out of the company and returning to its shareholders/investors then the pressure for the company's stock price would be tied to other factors besides profitability. Hence, one would imagine that the future price of the company's stock would be more closely tied to the number of shares available to trade - the supply of stock.

Sixth is that companies will no longer find it beneficial to issue stock options. It will be in the companies interest to retain as much equity as possible as it stands to keep the lion share of the distributed profits. This should show up in the difference between the shares outstanding and the float. This difference between these two figures should now decrease in the years ahead as companies entice employees with other perks other than stock options. As a matter of fact from May 2003 to August 2003, the float is increasing faster than the total supply which is putting more stock in the hands of investors than in the hands of employees. Expect the issuance of employee stock options to wane in the years ahead. As a matter of fact, watch the headlines as you should see an increase in corporate stock repurchase activity. This increase in activity will have the additional benefit of insulating investors from severe stock price erosion. This increased corporate stock repurchase activity will in effect put a lower limit on the company's stock price helping prices to remain near previous lows. Of course you as an individual investor will not be privileged to know whether the company will buy back stock just below previous lows or just above previous lows. But knowing that the company has committed itself to reinvesting in itself is enough to know that you aren't alone in seeing value in this company. You stand a better chance when the company believes in itself.

In summary, the spring rally in the market has everything to do with politics and nothing to do with technical analysis. Of course, the questions that remain are how long will demand continue and when will supply meet demand to temper prices. For the answers to these questions, the gathering of solid information can help but it can't definitively predict market reactions. Hopefully this graph has helped you to ask more questions and to help you make better investment decisions.