Understanding float can help you make wiser investments
Share structure, as we have discussed before, is a hugely important factor to consider when investing. The number of shares is important, but more telling is the number of shares available for trading... or float. Now, there are two important things to know when it comes to float:
- How to determine it; and
- What it means.
How to determine float
The simple way to calculate float is to take the total number of shares outstanding and subtract the number held by officers and directors. Officers and directors cannot trade their shares as easily as a regular investor. So, float assumes that these insiders have their shares tucked away in a safe deposit box. There are more shares taken into consideration than just those that directors and officers hold, however. Also tabulated are those held by "beneficial owners," or large holders of the stock.
Let's take a look at an example, a company has 25 million shares outstanding. Officers, directors and beneficial owners own 15 million shares. Twenty-five million minus 15 million equals 10 million. The company has a float of 10 million shares. That's 10 million shares that are available to the public market.
Finding a company's float can also be as easy as looking at its "Key Statistics" page on Yahoo! Finance, or some other research site.
What float means
Stock prices work on the principle of supply and demand. If there are less shares and more buyers, the shares become more valuable. If there are more shares and less buyers, the shares become less valuable. So, the fewer shares available to the public, the higher the demand when buyers are introduced. This is good for a stock's price, which rises as buyers rush in.
Less shares also means greater volatility, typically. This is because the fewer shares available, the less shares trade, generally speaking. A lesser volume leads to greater price fluctuations, or volatility, which is not always a bad thing.
A small float is not always a good thing, however. When a company goes public, there can be private placements on the stock, which are restricted. These placements must be registered with the SEC prior to being traded. Registration can take place two years after the company goes public. After registering the shares, the holders can sell them, increasing the supply, and thus depressing the stock price.
So, it is best to know who has the stock not in the float, and if there are any private placements that could increase the float, lessening the price down in the future.
What to take away
That last discussion of private placements may have confused you... Hopefully it didn't.
The short of this article is to know that float is the total numbers of shares available on the public market. The smaller the float, the less shares, supply, are available. Increase the number of buyers, demand, and the price will soar.
Be aware, however, a small float isn't always a good thing. As always, you must know what you are investing in.