When a stock has high institutional ownership, it is usually a good sign. If the institutions -- which include large investment banks, mutual funds and pension funds -- are the smart money in the market, having them invest in the company indicates the company is doing well. On the other hand, the institutions tend to move in their own direction and for their own reasons. At times, individual investors can do better by avoiding the companies that the largest financial institutions seem to love.
According to Luis Aguilar, commissioner of the U.S. Securities and Exchange Commission in 2013, in 1950, no more than 8 percent of the value of shares traded on U.S. markets was owned by institutions. In 2010, institutional ownership reached 67 percent. Furthermore, institutional ownership is concentrated even more in larger companies -- 73 percent of the largest 1,000 domestic companies were institutionally owned in 2009. With this in mind, institutional ownership is largely a reality in the modern stock market.
When institutions acquire stock, they sometimes do it by gradually buying up shares. Since many institutional investors buy large blocks of stock, they know that simply issuing a large buy order could cause the market to spiral upward, leaving them paying too much for the investment. However, gradual buying can also lead to a slow increase in price that isn't really based on the stock's value; it's just based on the institution's buying activity and could go away when the buying stops.
No Surprises Left
When institutions pile into a stock, it's usually a sign that the company's performance is a known quantity. This is a good thing, in that it means the company is probably projected to continue doing well. However, it comes at the cost of having something really great happen with the stock, as any significant upside usually gets priced in by the institutions when they first start acquiring it. As institutions buy up the stock based on their expectations of great things, the price moves up due to the increased demand, limiting the impact of those great things if they happen.
Periodically, institutions make moves that have nothing to do with the underlying fundamentals of a company or its stock. For instance, if a given company does particularly well and significantly outperforms the market, a fund could end up owning too much of its stock relative to other holdings. In those instances, the fund could sell large quantities of its shares, potentially leading to a significant price decline. To the institution, it's all in a day's business and has nothing to do with the stock itself. However, the individual investor who gets caught in this decline could be hurt by the loss of value.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.