What Is Free Float in Stocks and Why Does It Matter?
Explore the concept of free float in stocks and its impact on market dynamics. Understand why this metric is vital for investors.
Free float is a key stock market metric for understanding a company’s stock. It helps investors and analysts assess a stock’s behavior and market dynamics. By focusing on shares readily available for public trading, free float provides a more refined view than simply looking at a company’s total shares. This metric offers insights into a stock’s liquidity and potential for price movements.
Understanding Free Float
Free float refers to the portion of a company’s shares available for trading in the open market. These are the shares public investors can readily buy and sell. This concept is distinct from “total outstanding shares,” which represents all shares ever issued by a company, regardless of who holds them. Total outstanding shares include both actively traded shares and those held by entities unlikely to sell them in the near term.
Shares excluded from free float include those held by company insiders (such as founders, executives, and employees), government entities, and other companies (cross-holdings). Strategic investors with long-term stakes, private equity firms, and venture capital funds also have their holdings classified as non-free float. These shares are excluded because they are not readily available for public trading and their holders typically do not intend to sell them immediately, thus not contributing to market liquidity or price discovery.
Determining Free Float
Free float is determined by subtracting illiquid or restricted shares from a company’s total outstanding shares. These are shares not readily available for public trading. For instance, if a company has 100 million outstanding shares, and 20 million are held by insiders or strategic investors, the free float would be 80 million shares.
Major stock exchanges, index providers, and financial data services perform this calculation. Organizations like MSCI, S&P Dow Jones Indices, and FTSE Russell employ specific methodologies to identify and exclude non-free float shares. While the basic principle of subtracting restricted shares remains consistent, the exact criteria for exclusion can vary among different providers.
Why Free Float Matters
Free float impacts market liquidity, which refers to the ease with which a stock can be bought or sold without causing a substantial price change. A higher free float indicates greater market liquidity, making it easier for investors to execute trades efficiently. Conversely, a low free float can lead to increased price volatility because fewer shares are available for trading, meaning a single large transaction can have a more pronounced effect on the stock’s price.
Free float is also used to calculate “free-float adjusted market capitalization.” This metric multiplies a company’s share price by only its free-float shares, providing a more accurate representation of the company’s value in the public market compared to traditional market capitalization, which uses all outstanding shares. Major stock market index providers, such as the S&P 500, widely use this adjusted market capitalization.
Free-float adjusted market capitalization plays a role in index inclusion and weighting. Major stock market indices use this adjusted market capitalization to decide which companies are included and their weighting. This directly influences how passively managed funds, such as mutual funds and exchange-traded funds (ETFs) that track these indices, allocate their investments. A company’s free float can also influence investor perception, as stocks with a higher free float are seen as more accessible and less susceptible to the concentrated influence of a few large shareholders.