Institutions are mutual funds, pension plans, trust funds, and other large investors, and account for roughly 50 percent of all stockholdings. The presence of strong institutional sponsorship (large holdings) verifies that a stock is a viable growth candidate.

Institutional Percentage of Shares Outstanding

Institutions trade stocks frequently and in large quantities. By virtue of the large commissions their trades generate, institutional money managers are more wired into the market than individual investors can ever hope to be. Consequently, few public companies exist that they haven’t encountered.

High institutional sponsorship (ownership) means these tuned-in investors have analyzed the company and liked what they saw. Conversely, low institutional ownership means that institutions have analyzed the company and passed.

Institutions are required to report their holdings to the SEC only twice yearly. Most report more often, usually quarterly, and a few monthly. While the timeliness issue diminishes the value of institutional holdings data , it is still worthwhile, especially for growth investors, to evaluate the information.

Institutions, especially mutual funds, are most often growth investors and typically hold at least 40 percent of the outstanding shares of growth stocks. In many instances, institutional ownership runs as high as 95 percent of the outstanding shares. Growth investors should view candidates with less than 30 percent institutional ownership with caution. It could very well be that institutional buyers are shunning the stock for good reason.

It’s a different story for value candidates. Mutual funds and other institutional holders are inclined to dump their holdings when a stock tanks so big losers won’t show up on their quarterly reports. In theory then, low institutional holdings should signal an out of favor value candidate. But because of the reporting time lag, it could take a year for institutional selling to be reflected in the holdings data. Consequently, institutional holdings data is unlikely to be helpful to value investors.

Judging a Stock by the Company it Keeps

Checking the names of the funds holding large positions of a stock offers additional insight. Many sites report similar information, but I prefer this one because it lists Morningstar’s Star rating of each fund (Morningstar rates funds from one to five stars, where five is best). That’s good information because I’d rather buy stocks held mostly by five-star funds than those owned mainly by two-star funds.

The investing style of the funds with large holdings is also significant. Stocks mostly held by momentum style funds are riskier than those held mostly by buy-and-hold style managers because the momentum managers will dump their holdings at the first sign of trouble. You can tell which is which by looking up the fund’s portfolio turnover on Morningstar’s Portfolio report for the fund. Turnover measures the percentage of the fund’s trading activity. A 100 percent turnover means that, on average, the fund replaces its entire portfolio every year. Buyand- hold style funds have turnovers below 40 percent, and momentum fund’s turnovers typically run above 150 percent.