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The Free Float Ratio: Everything Investors Should Know

There are many indicators and multipliers for the analysis of listed companies. In this article, we will talk about one of them, the free float ratio. We find the formula for its calculation and explain how investors use it when analyzing the market situation.

How high is the free float?

The free-floating ratio is the number of shares available for public trading. They are traded on exchanges, not owned by strategic investors and available to retail investors. You may come across other known names – Float or Public Float.

Which stocks are not included in the free float calculation?

When calculating free floats, the following parts are not taken into account:

Owned by shareholders, company management and top executives
State owned
Owned by a large mutual fund that is the controlling shareholder
In addition, the limited partnership shares are also not taken into account. For example, shares given to an employee in return for his services to a company.

How is the free-floating ratio calculated

To calculate the free float ratio, we need to know the number of shares in the free float and the total number of shares outstanding. To make the formula look easy to understand, let's label each of these parameters as A and B.

The formula to calculate the free float ratio:

Free Float = A/B

The ratio can be specified in two formats – as a percentage (for example 50%) or as a decimal fraction (for example 0.5).

Say a company has 100,000 issued shares; Management owns 51% shares, 51,000 majority shares, while the remaining 49,000 shares have been put up for free circulation. In this case, the free float is 0.49 or 49%.

Free float calculation: 49,000 / 100,000 = 0.49

How to increase free float
A split is a stock split with a fixed split ratio. Through a split, the company increases the number of shares and lowers its price. For example, suppose a company owns 100 shares at $4 per share and after a 1:2 division, owns 200 shares at $2
Issuance of securities is a way to increase share capital and attract investment
Sale of shares by major shareholders – previously frozen shares are released for free circulation. There could be various reasons for this
How to reduce free float
A repurchase is a company's repurchase of its own shares. Once the company has raised enough available cash, it repurchases and withdraws its shares from its shareholders. This increases the proportion of large investors and their influence on the company
Delayed acquisition of securities by major shareholders for controlling interest
Reverse separation is the conversion of two or more shares into one of the same categories

Which free float values ​​are considered optimal?

The optimal free float for traders and investors is in the range of 40-80%. Such free-floating share volumes provide a form of protection against market volatility, increase instrument liquidity and provide the opportunity to buy or sell assets at any time. In other words, the higher the free float, the more liquid the instrument and the more options investors have.

Disadvantages of low free float

First, the market demand is small or limited. After buying several stocks, a trader may find it difficult to sell them. It is possible that no buyers in the market can acquire this asset or that the price is very low.

Second, at the time of a press release, there can be sharp price swings in both directions, which can cause panic among market participants.

Third, the purchase of a large number of shares by one investor can significantly increase prices and create imbalances. The sale of larger minority holdings may be delayed and may also result in price increases. In some cases, shares cannot be sold at all because no investor is willing to buy them.

How to use free float ratio for market analysis

First of all, ratios offer investors insight into the liquidity of an instrument. When the ratio is 40-80%, the instrument is considered quite liquid and carries lower trading risk.

A free float of more than 80% means it will be difficult for workers and large investors to cause higher volatility in the market by selling/buying shares in bulk.

A ratio below 40% indicates that the majority of shares are owned by major shareholders and they have the ability to influence share prices by listing many shares. The small number of shares in free floats creates additional difficulty in selling them.