Float adjusted shares

What Is Float Adjusted Shares?

Float adjusted shares refer to the portion of a company's common stock that is available for trading by the general public in the stock market. This figure excludes shares held by insiders, such as company executives, directors, employees, and large shareholders with controlling interests, as well as shares subject to restricted stock agreements or government restrictions. Float adjusted shares are a key metric in equity valuation and market structure analysis, providing a more accurate representation of a company's true tradable supply and its potential for liquidity.

This metric is distinct from a company's total outstanding shares, which include all shares ever issued, regardless of who holds them. The concept of float adjusted shares is critical for understanding a security's actual availability in the open market and its influence on price movements and market stability.

History and Origin

The concept of adjusting shares for public availability gained prominence with the evolution of global financial markets and the increasing sophistication of investment benchmarks. Index providers, such as MSCI (Morgan Stanley Capital International) and FTSE Russell, began adopting "free-float" methodologies in the late 1990s and early 2000s to create more investable and representative index funds. This shift recognized that a significant portion of a company's total shares might not be readily available for trading, distorting the true supply-demand dynamics and hindering the replicability of indices.

For instance, MSCI's methodology, which emphasizes index liquidity, investability, and replicability, defines free float as the total shares outstanding minus shares held by strategic investors (e.g., governments, corporations, strategic individuals) and locked-up shares¹⁰, ¹¹. This adjustment aimed to ensure that the indices accurately reflected the investment opportunities available to global investors. The Securities and Exchange Commission (SEC) also defines "public float" for regulatory purposes, calculating it by multiplying common shares held by non-affiliates by the market price.⁹ This regulatory definition aids in determining reporting requirements for public company entities.

Key Takeaways

• Float adjusted shares represent the portion of a company's stock readily available for public trading, excluding restricted shares and insider holdings.
• This metric is crucial for assessing a stock's market liquidity and potential volatility.
• Major stock market indices widely use float adjustment methodologies to ensure their constituents reflect genuine tradable supply.
• A higher float generally indicates greater liquidity and potentially less price manipulation due to broader distribution.
• It influences a company's market capitalization as perceived by index funds and passive investment strategies.

Formula and Calculation

The calculation of float adjusted shares begins with a company's total outstanding shares. From this figure, shares considered "non-float" or "restricted" are subtracted.

The formula can be expressed as:

$\text{Float Adjusted Shares} = \text{Total Outstanding Shares} - \text{Non-Float Shares}$

Where:

• Total Outstanding Shares: All shares of a company's stock that have been authorized, issued, and purchased by investors.
• Non-Float Shares: Shares typically held by:
  • Company insiders (e.g., founders, executives, directors).
  • Strategic institutional investors with long-term, non-trading intent.
  • Shares subject to lock-up agreements (e.g., following an Initial Public Offering (IPO))).
  • Government holdings.
  • Shares held in employee vesting plans that are not yet liquid.

The Securities and Exchange Commission (SEC) defines public float as the aggregate worldwide number of shares of a company's voting and non-voting common equity securities held by non-affiliates, multiplied by the price at which the common equity was last sold.⁸

Interpreting the Float Adjusted Shares

Interpreting float adjusted shares is essential for investors and analysts to gauge a stock's true tradable supply and its implications for market dynamics. A high number of float adjusted shares typically indicates greater liquidity, meaning the stock can be bought and sold easily without significantly impacting its price. This is because a larger pool of shares is available for public trading, making it easier for buyers and sellers to find counterparties. Conversely, a low float can suggest lower liquidity, potentially leading to higher price volatility as even small trading volumes can have a disproportionate effect on the stock price.

This metric helps investors understand the potential for price movements and the ease with which large positions can be established or liquidated. For example, a company with a small float might experience rapid price swings if a major news event triggers significant buying or selling pressure, simply because there are fewer shares available to absorb the demand or supply.

Hypothetical Example

Consider "Tech Innovations Inc.," a hypothetical software company.

• Total Outstanding Shares: 100,000,000 shares
• Shares held by Founder & CEO: 20,000,000 shares (restricted)
• Shares held by Board of Directors: 5,000,000 shares (restricted)
• Shares held by Venture Capital Firm (strategic long-term holder): 10,000,000 shares (non-trading intent)
• Shares held by Employee Stock Option Plan (unvested): 5,000,000 shares

To calculate the float adjusted shares for Tech Innovations Inc.:

$\text{Float Adjusted Shares} = \text{Total Outstanding Shares} - (\text{Founder Shares} + \text{Director Shares} + \text{VC Firm Shares} + \text{ESOP Unvested Shares})$
$\text{Float Adjusted Shares} = 100,000,000 - (20,000,000 + 5,000,000 + 10,000,000 + 5,000,000)$
$\text{Float Adjusted Shares} = 100,000,000 - 40,000,000$
$\text{Float Adjusted Shares} = 60,000,000 \text{ shares}$

In this example, 60,000,000 shares are considered float adjusted, representing the true supply available to public investors. This figure would be used by index providers to determine the company's eligibility and weight in a float-adjusted index.

Practical Applications

Float adjusted shares are a fundamental component in several areas of the financial industry:

• Index Construction and Management: Leading index providers like MSCI and FTSE Russell use float adjustment as a core methodology for creating and maintaining their global equity indices. This ensures that indices accurately represent the investable market and that index-tracking products, such as exchange-traded funds (ETFs) and mutual funds, can effectively replicate their performance. An index's free float-adjusted market capitalization is a primary determinant of a company's weight within that index.⁷
• Liquidity Analysis: Analysts and investors use float adjusted shares to assess a stock's tradable liquidity. A higher float implies that large orders can be executed with minimal price impact, facilitating easier entry and exit for investors. Conversely, a low float can indicate potential for significant price swings with relatively small trading volumes, affecting strategic trading decisions. The liquidity of a stock can have real effects on a firm's investment and production decisions.⁶
• Regulatory Compliance: Regulatory bodies, such as the SEC, consider public float when categorizing companies for reporting requirements. For instance, a company's public float can influence whether it qualifies as a smaller reporting company, which may have scaled disclosure requirements.⁵
• Risk Management: Portfolio managers consider float when managing portfolio risk, particularly for large positions, as it impacts the ease of exiting a trade without significant market disruption. This also affects institutional investors' ability to take meaningful positions.

Limitations and Criticisms

While float adjusted shares offer a more realistic view of market supply, they are not without limitations. One criticism is the inherent subjectivity in determining which shares constitute "non-float." Different index providers or regulatory bodies may have slightly varied definitions of what constitutes a restricted share or an insider holding, leading to inconsistencies. For example, the SEC's definition of an "affiliate" can be discretionary for firms, especially concerning blockholders.⁴ This discretion can sometimes lead to different reported public floats for the same company across various sources.

Furthermore, the calculation of float adjusted shares is a snapshot in time. Shareholdings can change due to secondary offerings, insider sales, or the expiration of lock-up periods, requiring regular re-evaluation. While major index providers regularly update their float data, there can be a lag between changes in ownership structure and their reflection in public float figures. For instance, MSCI states that updates occur once public disclosures of the complete post-event shareholder structure are available.³ A significant issue is the limited liquidity for shares held by founders and executives, especially after an IPO, due to lock-up periods, which are designed to prevent a large sell-off that could decrease the stock price.¹, ²

Float Adjusted Shares vs. Outstanding Shares

The distinction between float adjusted shares and outstanding shares is crucial for a nuanced understanding of a company's stock structure.

While total outstanding shares provide a complete picture of a company's issued equity, float adjusted shares offer a more practical view for market participants by focusing on the supply that is genuinely available for purchase and sale in the open market. This difference is critical for understanding the mechanics of how a stock's price behaves.

FAQs

Why are float adjusted shares important for investors?

Float adjusted shares are important because they indicate a stock's true tradable supply. This helps investors assess a stock's liquidity and potential for price volatility. A stock with a higher float is generally easier to buy and sell without causing significant price movements.

How do index providers use float adjusted shares?

Index providers like MSCI use float adjusted shares to determine a company's weight in their equity indices. This ensures that the indices reflect the investable market and allows index funds to accurately track the performance of these benchmarks, as only readily available shares are considered.

What types of shares are typically excluded from the float?

Shares typically excluded from the float include those held by company insiders (such as executives, directors, and founders), large blockholders with controlling interests, governments, and shares subject to restricted stock agreements or lock-up periods following an IPO). These are shares not readily available for public trading.