What is the float in trading stocks?

Monday, October 15, 2018 | MarketBeat Staff
What is the float in trading stocks?

When an investor buys shares of a company, they become a part owner of that company. Being a shareholder means you share in the company's success by having the potential to have your investment increase if the company's stock price increases. You also share some of the risks because your investment could lose money if the stock price goes down.

Companies issue shares of stock for a variety of reasons, but one of the most common is to raise capital without having to take out a loan (i.e. take on debt). In exchange for buying a company’s shares, shareholders are rewarded with certain rights, such as voting rights at shareholder’s meetings. However, as much as a company may want, or even need, the equity that can come to them from shareholders, they do not want to issue so much stock that any individual, or group of, investors could simply buy up the company. For this reason, some shares of stock are unavailable for the public to purchase, and companies have reporting structures such as a board of directors that determine precisely how many shares of a company will be available on the secondary market.

This introduces a concept called float. In this article, we'll provide a definition of float, how floating shares are different from other kinds of shares. We'll also look at the things companies can do to increase or decrease the number of floating shares that are available.

What is the float?

Float refers to the number of shares that a company issues that are available for trading on secondary markets without restriction. They are sometimes referred to as outstanding shares. While this may be the case, there are times when there are outstanding shares that are not considered to be “in float”. For example, a company may issue stock options to employees. If an employee is awarded these options, there is usually a time period that these shares are restricted or “locked up” from trading. So even though the shares are technically available for trade, they are still considered restricted shares.

How are floating shares different from other kinds of shares?

The biggest difference between floating shares and other kinds of shares is that floating shares can be traded on secondary markets. However, as we’ve pointed out, the number of floating shares does not represent the total amount of shares a company can issue.

When a company “goes public”, they are required to draft articles of incorporation. As part of the articles of incorporation, the company sets a maximum number of shares that they can issue. These are known as authorized shares. The only way the number of authorized shares can be changed is by the vote of shareholders. This makes sense, because if too many shares of stock are made public, the value of each share may go down. If too few shares are issued, the stock may become too volatile (i.e. it would take the trade of fewer shares to cause a large swing in the stock price).

Not all authorized shares are the same. There are three categories of authorized shares: treasury stock, restricted shares and outstanding shares (which for the purpose of this article we’ll call floating shares). Here’s a brief breakdown of these categories:

Treasury stock: This defines shares of stock that are held by the company itself. For privately held companies, this is usually the owners, other family members and, in some cases, top executives.

Restricted shares: This defines shares of stock that are issued to executives and directors of a company, as well as other affiliates. When you hear the phrase "stock option" these are the types of shares being referred to. They are a form of compensation. However, once an employee receives these shares, the shares are subject to a waiting period (sometimes referred to as a "lock-up" period). During this time, the employee cannot transfer their stock and restricted from trading except in compliance with special Securities and Exchange Commission (SEC) guidelines. The basic reason for the restriction is to prevent insider trading. For example, if an executive had reason to believe the company's stock was going to fall, they could immediately sell their shares. Forcing employees to hold on to the stock is an incentive to ensure that the decisions they make are for the betterment of the company. For this reason, some analysts consider it a good sign when a company has a healthy percentage of restricted shares.

These shares are typically regarded as a form of employee compensation and are available to the recipient after a designated “vested” period. Recipients of restricted shares cannot transfer their stock and can only trade the shares in compliance with special Securities and Exchange Commission (SEC) regulations.

Floating shares: This defines the remainder of the authorized shares that can now be traded on the secondary market. Although the term outstanding shares is sometimes used interchangeably with floating shares, the distinction is that floating shares do not include restricted shares. However, once the shares are outside of the vesting period, they would be counted as outstanding shares.

To illustrate this, let’s say a company issues 2,000 authorized shares of stock. Of this amount, they designate 400 shares as treasury stock and 300 additional shares as restricted shares. The number of floating shares would follow this formula:

Authorized shares – (Treasury stock + Restricted shares) = Floating shares

So for our example, you would have

2,000 shares – (400 shares + 300 shares) = 1,300 floating shares

How can you know how many shares are floating?

If the company is a publicly traded company, you can find the number of outstanding shares from a company’s balance sheet. This would be found in the section titled “Shareholder’s Equity”. You can find the balance sheet on the company’s website in a section titled “Investor Relations” or something similar. You can also typically find this information on any financial news websites where stock quotes are displayed. Publicly traded companies are required to deliver earnings reports with the Securities & Exchange Commission every quarter.

How does a company increase their floating shares?

There are three common ways for a company to increase their number of outstanding shares:

  1. New equity financing– When a company looks to raise capital through private investors, they will approach their board of directors about issuing additional outstanding shares. The number of floating shares will be determined once the number of restricted shares is calculated. This option is typically only available to established companies that have assets and cash flow that will provide collateral. This is important because investors will look for some assurance that the shares they hold will not become worthless.

 

  1. Employees exercise stock options– As we’ve already mentioned, a company may designate a certain number of outstanding shares as restricted shares that they can issue to employees as stock options. When these are first issued, they cannot be traded on secondary markets. However, once the "lockout" period ends, these shares will now become floating shares.

 

  1. Stock splits – When a company issues a stock split, they are doing two things. First, they are trying to create additional liquidity in their existing stock. And second, they are allowing their stock price to drop, making it more attractive to public investors. If an investor owns 200 shares of a stock that are priced at $40 a share, their investment is worth $8,000. If the company issues a two-for-one stock split, they will now own 400 shares, but the stock price will now be $20 per share, leaving their investment value unchanged at $8,000.

How does a company decrease their floating shares?

There are ways that a company can decrease their number of floating shares. The two most common are:

  1. Issue a stock buyback– Stock buybacks used to be considered somewhat unethical, but they have become a common way for companies to increase their stock's share price. As the name suggests, in a stock buyback a company purchases shares that are in the float. In doing so, they will either cancel the shares altogether or turn them into treasury stock. In many cases, analysts see this as a good sign because if companies are buying their own shares, they believe the stock is undervalued. However, if analysts perceive that a company is undertaking a buyback to make their performance look better than what it was; this program the buyback may have the opposite effect intended.

 

  1. Conduct a reverse stock split– Just as a stock split increases the number of shares an investor owns, in a reverse stock split, their number of shares decreases. In our earlier example, if an investor owns 200 shares of a stock at $40/share, a two-for-one reverse stock split would leave the investor with 100 shares valued at $80/share. Reverse stock splits are more concerning to analysts because it may mean that they are trying to artificially increase the value of their stock. This can result in the stock suffering a larger sell-off.

Why is it valuable to understand float?

For the purposes of answering this question, we’ll make floating shares the same thing as outstanding shares. While there is a difference between the two terms, it is a semantic difference in this context. The number of outstanding shares a company has in the market is used to calculate key metrics such as market capitalization and earnings per share. An even more simple reason has to do with simple supply and demand. The value of each share has an inverse relationship to its price. The more shares that are available for trading, the less each share will be worth and vice versa.

Furthermore, it’s always important to understand why a company is issuing new shares. If they are issuing too many shares too quickly, the price of every share can drop. If a company has a high amount of outstanding shares relative to other companies in their sector, that can be a warning sign.  

The bottom line on the float

Float, or floating shares, refers to the number of outstanding shares issued by a company that is available to be publicly traded at a given time. Although commonly used synonymously with outstanding shares, floating shares are actually a very specific subcategory that does not include restricted shares (i.e. shares that companies issue as stock options for the purposes of employee compensation).

Companies are not responsible for how these shares are sold, that is up to the market, but they are solely responsible for how many shares are available to be traded at a given time.

When floated shares are traded, the number of floated shares remains the same. In this case, shares that exchange hands represent a transfer of ownership, not an issuance of new shares. The exception to this would be if a company issues a stock buyback in which they purchase outstanding shares, thus removing them from circulation.

As an investor, the number of floating shares a company has available can help investors who are performing fundamental analysis determined metrics like market capitalization and earnings per share. Furthermore, because shares are subject to market dynamics, price and available shares typically have an inverse relationship. If an investor finds that a company has a high amount of floating shares relative to other companies in their industry, it could be a sign that the company is in trouble.

 

 

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