What is free-float or free-float stock?

Free-float shares what is it?

The volume of issuer’s securities traded on the stock market shows its liquidity and attractiveness for investors. The future fate of a company sometimes also depends on the traded assets, for example, if a large investor plans to buy a “controlling stake”. One of the ratios, Free-float, is used to account for financial instruments. The review discloses the essence of the concept and publication channels of this indicator. Additionally, the shares that are not included in the calculation of the value are given.

Notion of Free-Float

Free-float is a coefficient reflecting the share of shares of a certain issuer available for investors. That is, this is a number of assets which private persons not associated with a company may buy to replenish their own investment portfolio. Free-float is one of the main parameters in determining the price of securities on the stock market.

The index is expressed in money units or percents. A low value indicates the availability of a small number of the company’s securities for purchase and sale agreements. Due to the tight relationship of the coefficient with the liquidity of the issuer, it is noteworthy that in this case it decreases. During the organization of active trading in shares, low free float sometimes becomes a problem. The negative side is noted by private investors and speculators. For example, it is unprofitable for the second market participants to trade such assets because of the high value of the spread, which implies only losses.

Example: An enterprise has issued 10,000 shares. Only 1,000 assets of the total issue were placed in free float. Free-float equaled 10% or 0.1 = 10 000 / 1 000.

The use of the coefficient

Big players and small investors benefit most from the value. It determines the reliability and liquidity of the asset, as well as its issuer. A low free-float of a stock puts investors on alert, even if the company has a high rating and a positive image.

The large volume of securities available makes it difficult for majority investors to influence their value. A high free-float reduces the risk of significant price fluctuations. The optimal value is in the range of 0.4 to 0.8.

Knowledge of the ratio helps a trader to choose an effective trading strategy on the exchange floor:

  • Purchasing shares with a low free-float involves tracking news about the issuer, as well as monitoring supply/demand and daily turnover.
  • Investing in high-float securities simplifies the approach, but tracking news information about the company remains a must.
  • With a ratio of less than 0.15, the investment risk is high. Buy and sell transactions are more problematic because of the small volume of stock, narrow market, and uncertainty in the outlook.

Example: The value is less than 5% and the majority owner owns the remaining 95% of the shares. He has the right to oblige the investor to get rid of his share at a certain price, even if the offer is unprofitable for the holder of several assets.

Increase and decrease of free-float

The ratio tends to change along with the increase or decrease in the shareholdings of the majority and minority investors. A decrease in the value causes a buyback of financial instruments. This is carried out to increase the controlling block of securities at the expense of assets previously in free float on the market. Additional purposes of performing a buyback are:

  • reducing the risk of a takeover of a controlling interest in a hostile takeover;
  • to maintain the market value of the company;
  • to change the structure of the authorized capital;
  • to invest financial surplus;
  • obtaining additional profits.

Increases the value of additional issue of financial assets. The main purpose of this method is to raise money to increase the authorized capital. Otherwise, a large block of securities of the majority shareholder or owner risks being sold out.

What shares are not included in the free-float?

Not all of the securities of a particular issuing company are included in the calculation of the free float ratio. Exceptions include:

  • Shareholders holding more than 5% of the issuer’s total shares. This includes: owners, senior management and strategic asset holders.
  • Restricted shares. For example, presented to employees as compensation for their work.
  • Assets held by insiders because of the belief that they hold securities for a long time.
  • An insider is a member of a group who, because of his or her own job or family status, has access to confidential information about the company’s operations that is not available to the general public.

Where can an investor look up free-float data?

Data on free-float of securities is publicly available. Information on Russian and foreign companies can be found on the following portals:

  • Nasdaq
  • Financial and economic publications, e.g. Financial Times

The indicators presented on these sites are reliable and up-to-date. It is difficult to calculate the coefficient independently due to the need for preliminary research of the issuer and comparative analysis. Using online resources that regularly publish updated figures for stock market securities simplifies the investment selection process.

Who works with Free Float?

In practice, all shares issued by an issuer are distributed among many different funds, banks and private investors. At this stage, it is possible to divide the owners into several groups. Each of these groups has a different effect on the ratio of freely tradable shares.

Free float first group is the direct owners of the business. They are financial companies or individuals which aim at managing the company or substantially influencing the decision-making inside the structure they own a part of. Accordingly, they are interested in holding in their hands a “controlling block” of shares or a significant proportion of the total volume. The securities from such portfolios are not quoted on the stock exchange and act as an antipode to Free Float.

The next group is institutional investors. They are similar to the first group in many respects, but their stake in the business does not allow them to have any influence on corporate-level decision-making. Such market participants, first of all, evaluate long-term prospects of a particular enterprise and, if the forecasts look profitable, buy its shares at the exchange. These investors expect to receive both dividend income and income from changes in the market value when they sell their shares several years later. Unlike the first group, they are not interested in managing the business.

The latter group uses shares as an instrument of speculative trading. With this approach, profits are generated solely through changes in exchange rate value. This group mainly forms the free float of securities on the market.

The Free Float ratio is an important parameter in determining the price of the stock on the stock market.

Below we will consider how the Free Float ratio is calculated. In fact, it is the volume of assets, which do not belong to insiders. In Russia, however, this figure is not so easy to calculate due to the lack of basic information on the volume of securities from the affiliated companies and their management. American and European issuers have Free Float values ranging from 1 to 100%. If the total trading volume is low, it indicates a low Free Float. This fact, in its turn, has a negative impact on the liquidity level and opens the way for price manipulations.

If Free Float is too low, a large flow of buyers can shift the price of the asset upwards. In a situation where shares have low liquidity, there may be no buyers in the market at all. This issue is particularly acute when the asset is traded on several sites at once, separated geographically. Because of low liquidity, a situation may happen on one of the exchanges, when the number of buyers exceeds the number of sellers (or vice versa). This will lead to a one-time significant “piercing” of the price in the direction whose side was weaker. At the same time, the other markets would still hold an adequate real price. At the moment, until arbitrageurs eliminate the price deviation and level out the price, traders on the given floor will bear increased risks and in fact will not be able to open positions in the given instrument at an adequate price.

Increasing and Decreasing Free Float

A company’s management can control the number of shares outstanding. For example, a company can increase the amount of free float by conducting a stock split or by selling its own shares that it owns.

Similarly, if the company decides to conduct a stock buyback or reverse stock split, it can reduce the number of shares of free float.

Stock Split

There are several ways to increase stocks in a Free Float state. One of them is the so-called “split. This procedure involves a sequential split of the issued shares.

For example, a company has issued 10 million shares at $100. Out of them 2 million are in free float and form Free Float, and 8 million are in the hands of insiders. Over 5 years, the shares have actively increased in price, and at the moment the value of one paper is $10,000.

In such a situation, small private investors begin to lose interest in this company because of the high cost per share. This, in turn, leads to liquidity reduction and, as a whole, negatively influences the dynamics of assets.

This problem can be solved by carrying out the procedure of splitting 1 to 100, after which the owner of 1 share of $10,000 will become the owner of 100 shares, worth $100 each.

As a result of this procedure the number of Free Float shares increases and the number of transactions increases, but the stakes of business owners and the total capitalization of the issuer remain unchanged, because the number of securities increases, not their percentage ratio.

Repurchase of shares

There is a mirror operation to the “split. It is called a “reverse split,” or “consolidation,” and it in turn reduces the number of shares in Free Float.

Stock repurchase refers to the management of a public company buying back stock that has previously been sold to investors in the stock market.

There are several reasons why a company may decide to repurchase its stock. For example, a company may decide to repurchase stock to send a market signal that their stock price may increase, to inflate the financial performance expressed by the number of shares outstanding (such as earnings per share or EPS), or to try to stop a declining stock price, or simply because it wants to increase its equity stake.

Also, for example, the NASDAQ stock exchange sets a minimum price of $1 per share, so doing a consolidation would solve these problems for the issuer, although it would reduce the number of shares in free float. After the consolidation, the owner of 10 shares worth $0.50 each will get 1 share worth $5 after the 10-to-1 consolidation.

Some mutual funds operating in the financial markets may have certain formal guidelines. For example, not to buy shares worth less than $1. Also, the stock exchanges themselves may have requirements on the original value of the securities before they are allowed to trade.

When a company repurchases stock, the Free-Float share decreases. This fact paves the way for several different phenomena.

  1. First, many fundamental analysis metrics, such as earnings per share (EPS) or cash flow per share (CFPS) , will increase because of the reduction in the denominator used to derive the data. Thus, investors should be cautious of the situation because EPS and CFPS will become artificially inflated – meaning that the increase cannot be attributed to economic value-creating activities such as increased profits or reduced expenses.
  2. Second, following the concept of supply and demand, we can predict an increase in the stock price. Assuming that the demand for the stock remains constant in the face of supply reductions, we can predict that the stock price will rise.

Stock buybacks also reduce the Free-Float of the stock, reducing the liquidity of the stock. This can affect trading and stock valuation (Free-float decreases, stock price increases).

Firms cite a lack of attractive investment opportunities due to overcapacity and a lack of pricing in defense of buybacks.

Critics, in turn, point to firms that choose to underinvest and maximize short-term returns – share repurchases boost share prices by increasing earnings per share – among senior managers, stocks and options often account for most of their bonus income.

Kevin Doran

I have been trading forex since 2015. Over the past few years, I have tried and tested all the most popular Forex Brokers. I publish my reviews to help you choose a reliable broker and reduce your risks.

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