What Is Free Float and Why Is It Important?
Discover free float: the essential financial metric that defines a company's publicly traded shares and its crucial impact on market dynamics.
Understanding how a company’s shares are distributed is important for investors. A key metric providing insight into this distribution is “free float.” This concept clarifies which shares are readily available for trading in the open market, distinguishing them from those held for long-term, strategic purposes.
Defining Free Float
Free float, often referred to as public float, represents the portion of a company’s total outstanding shares actively available for trading by the general public in the open market. This metric differs from a company’s total outstanding shares, which include all shares ever issued. Free float focuses on shares that are freely tradable or publicly available to investors.
Free float identifies shares not held by insiders, strategic investors, or other entities with non-trading intentions. These excluded shares are typically held for control, long-term investment, or other purposes that do not involve regular buying and selling on exchanges. By focusing on the tradable portion, free float provides a more realistic picture of a stock’s supply in the market.
Shares Included and Excluded from Free Float
The determination of free float involves identifying specific categories of shares that are either readily available for public trading or are considered restricted from the market. Shares typically included in the free float are those held by individual investors, mutual funds, pension funds, hedge funds, and various other institutional investors. These entities generally acquire shares with the intention of trading them on public exchanges, contributing to market liquidity.
Conversely, several types of shares are generally excluded from the free float calculation because they are not considered freely tradable. These include:
Shares held by founders, promoters, or controlling shareholders, who often retain large stakes for corporate control or long-term strategic interests.
Shares held by governments or state-owned entities, as their holdings are not primarily for market trading.
Shares subject to lock-up periods, such as those issued after an initial public offering (IPO), which cannot be sold for a specified duration.
Treasury shares, which are shares repurchased by the company itself.
Shares held in employee stock ownership plans (ESOPs) that are not yet vested or tradable.
Calculating Free Float
Calculating free float involves a straightforward subtraction to determine the number of shares available for public trading. The basic formula subtracts restricted or non-float shares from the total outstanding shares of a company. This calculation provides the actual number of shares that are readily accessible to investors in the open market.
For instance, if a company has 100 million total outstanding shares and 40 million of these shares are held by founders, strategic investors, or are subject to lock-up periods, then the free float would be 60 million shares. This 60 million represents the portion of the company’s equity that can be bought and sold by the general public.
Free float can be expressed not only as a specific number of shares but also as a percentage of the total outstanding shares. Using the previous example, a free float of 60 million shares out of 100 million total outstanding shares would equate to a 60% free float percentage. While the core principle of this calculation remains consistent, different financial institutions or index providers may have minor variations in their specific methodologies for identifying and classifying “restricted” shares.
Significance of Free Float
Free float is an important metric in financial markets because it directly influences market dynamics, investor behavior, and a company’s perceived value. A higher free float generally leads to greater market liquidity, which means investors can more easily buy and sell shares without causing significant price fluctuations. This enhanced liquidity makes a stock more attractive to a broader range of investors, as it reduces the risk of being unable to execute trades efficiently.
The concept of free float is also fundamental to calculating “free-float market capitalization,” a more refined measure of a company’s investable market value. Unlike traditional market capitalization, which considers all outstanding shares, free-float market capitalization only accounts for the shares available for public trading. This adjusted valuation is particularly important for stock market indices, such as those maintained by S&P, FTSE, or MSCI.
Major stock market indices widely use free-float adjusted market capitalization to determine which companies are included in their indices and their respective weightings. This methodology ensures that these indices accurately reflect the true investable universe and are not disproportionately influenced by shares that are not actively traded. The inclusion in or exclusion from an index can significantly impact a stock’s demand and visibility among institutional investors, including index funds and exchange-traded funds. Furthermore, increased liquidity from a higher free float contributes to more efficient price discovery, as a larger pool of buyers and sellers can more accurately determine a stock’s fair market value.