What is Free Float
Free float refers to shares of a company that are not restricted and are available to the public for trading in the secondary market. Restricted shares are those held by company insiders, directors, vested employees, or affiliated trusts and foundations. They are typically held for the long term and generally are not available for public trading. Investors need to understand a company’s free float because it gives an insight into the stock’s volatility and liquidity.
Free Float Formula – Shares Outstanding vs Float
Free float can be viewed as an absolute figure or a percentage. As an absolute figure, the formula is:
Free float = Outstanding Shares – Restricted Shares
Where:
- Outstanding shares are all shares issued by a company.
- Restricted shares are the locked-in shares that include those held by company founders, government, company officers and directors, long-term shareholders, as well as affiliated trusts and foundations. They can also be stock kept in the company books.
As a percentage, the formula for free float is:
Free float Percentage = (Free Float/Outstanding Shares) * 100
Example of Free Float
Consider Company A has issued 1,000,000 shares outstanding. Out of these, the founders have been allocated 200,000 shares, and the company’s foundations hold 100,000 shares. The Free Float will be calculated as follows:
1,000,000 – (200,000 + 100,000) = 700,000
The Free Float percentage = (700,000/1,000,000) * 100 = 70%
Changes to Free Float
The free float of a company can increase or decrease depending on management decisions or other time-barred factors. For instance, a company may increase its free public float by issuing new shares or implementing a stock split. The free stock float can also increase when insiders or employees of a company exercise their stock options after achieving certain time or performance milestones.
A company can also reduce its free float by implementing a share buyback policy. In this way, a company buys its own shares in the open market. They can also reduce the free float by implementing a reverse stock split.
Why is Free Float Important?
Free float is a very important metric for investors because it helps them pick out the stocks to trade or invest in more effectively. There are high float stocks and low float stocks, and they all have different characteristics and offer different risk/reward propositions.
High float stocks are those that have a decent-to-low level of insider and government ownership. They tend to be stocks of large, well-established companies. High float stocks tend to have more stability and low volatility. There is also minimal risk of single session significant price spikes. Because of the huge number of free float shares, it is very difficult to manipulate the high float stocks in the short term. These stocks also tend to have high liquidity and tight bid-ask spreads.
High float stocks appeal to risk-averse investors who prefer long-term stable growth to short-term unpredictable gains. However, the low level of insider ownership can also be a cause of concern. It may mean that top management has little faith in the future prospects of the company. Some examples of high float stocks are Microsoft and Amazon.
On the other hand, low float stocks are those that have a high level of restricted shares (insider or government ownership). They tend to be stocks of young or lesser-known companies as well as historical family-owned businesses. Low float shares tend to be highly volatile and can sometimes experience sharp and huge short-term price spikes. This is because they theoretically have a limited number of shares available to trade and any slight trigger can cause dramatic price changes.
Low float stocks are ideal for short-term traders that seek high risk/high reward momentum trading opportunities in the market. A high level of insider ownership may not necessarily be a bad thing because it can imply that the top management has confidence in the future prospects of the company. But low float stocks typically feature low liquidity and are often available for trading with wide bid-ask spreads.
A recent case of a low float stock is GameStop. The company’s management had, for a long time, implemented a share buyback policy that left only a small amount of shares available to the public. The stock became a target of investors of a social media platform who managed to literally ‘corner’ it, causing a huge spike in its price over a relatively short period of time.
Final Words
Free float helps investors to assess a company’s ownership structure as well as the overall risk/reward proposition of its stock. It can also provide interesting trading and investing opportunities when the free float of a company changes at any given time.
Open an account with AvaTrade and trade the opportunities provided by both high float and low float stocks in the market.
FAQ
- What is Free Float?
Free float = Outstanding Shares – Restricted Shares
- How to calculate Free Float Percentage?
Free float Percentage = (Free Float/Outstanding Shares) * 100
Open a Demo account to practice what you’ve learned or a Real account to start trading today!
