What is float?
In the financial world, there are at least two different meanings of the word “float.” One refers to money that is counted twice for a brief amount of time due to delays in processing checks; the other refers to the number of a company’s outstanding shares that is available to the public for trading. Let’s focus on the latter.
First, let’s take a look at how we arrive at the number of a company’s float: Take the outstanding shares and then subtract from it the company’s restricted shares. Also known as restricted securities, restricted shares are not available to the public because these are owned by the company’s officers, management, and employees if the company has an existing Employee Stock Ownership Plan (ESOP). Restricted shares have a long-term ownership basis, and, should the right price come around, the holder of the stock needs to get permission from the Securities and Exchange Commission (SEC) to sell.
If you’re a new investor, you may want to hold off on low-float stocks until you’re sure about your tolerance for risk (or until you read the rest of this article).
How does float affect investing?
Understanding the significance of float can help you determine whether you’re purchasing highly volatile shares or not. Prospective investors would do well to look at a company’s float to get valuable insight on the stability of a stock.
Institutional investors, such as banks or an insurance company, usually prefer investing in stocks with a large float because this allows them to purchase or sell a significant number of shares without creating an impact on the share price.
In reverse, stocks with small floats are more volatile because there are only a limited number of shares that can be bought or sold, especially in the event of trading news which affects stock prices. Companies with bigger floats tend to be less volatile because of a large number of shares available for trading. It’s all about how significant the impact is on supply and demand.
For example, suppose company ABC has 70,000 outstanding shares. The breakdown of the float is as follows: the parent company holds 20,000; management and other company insiders hold 25,000, and employees through ESOP own 5,000, leaving 20,000 in floating stock, which is available for the public to trade.
There is no industry benchmark upon which investors can identify if a specific company has a high or low float. But many financial experts draw the line between 10 to 20 million freely-traded shares.
What can you do when you’re trading low-float stock?
When trading low-float stock, it’s important to look for liquidity—how fast a stock can be bought or sold without affecting the price. Many seasoned investors advise against holding on to shares that you cannot trade. The chances of getting stuck with non-tradable stocks increase before a big news event. So, always be on the lookout for significant company announcements that can affect stocks’ liquidity.
However, there is also an upside to trading low-float stocks; due to its highly-volatile nature, huge rewards can be in store for investors with an appetite for high risk. So, it’s best to determine first your tolerance for risk before taking your chances with low-float stocks.