The Free Float Ratio: What It Is, How to Calculate It and Why It Matters
Free float is the share of a company's stock that is available for trading on the exchange, excluding shares held by founders, management, the state and strategic investors. The free float ratio is the number of freely traded shares divided by the total number of shares issued. A higher free float usually means better liquidity and steadier prices.
TL;DR
- Find the number of freely traded shares and the total number of shares issued, and divide the first by the second.
- Read the result: below 40% means limited liquidity, 40 to 80% a liquid stock, above 80% deep liquidity.
- Watch for events that change the free float, such as buybacks, share sales by major holders and new issues.
There are plenty of indicators and multipliers for analysing public companies. In this article, we’ll talk about one of them, the Free float ratio. We’ll find out the formula for calculating it and describe how investors use it when analysing the market situation.
What the Free Float Ratio Is
The Free float ratio is the quantity of shares available for public trading. They are traded on stock exchanges, are not owned by strategic investors, and are available to retail ones. You can meet other names it goes by: Float or Public Float.
What shares are not included in a Free float calculation?
When calculating the Free float ratio, the following shares are not included:
- Owned by shareholders, the company’s management and top managers
- Owned by the state
- Owned by big investment funds, which are majority shareholders
In addition, limited shares are also not taken into account. For example, shares that were given to an employee as a reward for the merits for a company.
How the Free Float Ratio Is Calculated
To calculate the Free float ratio, we need to know the number of free float shares and the total number of shares issued. To make the formula look easy to understand, we’ll denote these parameters as A and B, respectively.
The Free float ratio calculation formula:
Free float = A / B
The ratio can be specified in two formats: in percentage (for example, 50%) or decimal fraction (for example, 0.5).
Let’s say that a company issued 100,000 shares; 51% of them, 51,000, a majority stake, are owned by the management, while the rest 49,000 shares were released for free circulation. In this case, the Free float ratio will be 0.49 or 49%.
The Free float calculation: 49,000 / 100,000 = 0.49
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Free Float vs Market Cap
Market capitalisation is the value of all a company's shares: the total number of shares multiplied by the share price. Free float market capitalisation counts only the shares available for trading. Take the example from the formula section: 100,000 shares, 49,000 of them in free float, at 4 USD per share. The market cap is 400,000 USD, but the free float market cap is only 196,000 USD.
The gap between the two matters because only the free float can change hands. Two companies with the same market cap can trade very differently if one of them has most of its shares locked with founders or the state. For a trader, free float market cap is the better guide to how much money can move in and out of the stock without pushing the price too far.
Free Float Adjusted Index Weighting
Major stock indices weight their members by free float market capitalisation, not by total market cap. S&P Dow Jones Indices, FTSE Russell and MSCI all use this method. A company whose founders hold half the shares gets roughly half the index weight its full market cap would suggest.
The reason is practical: index funds have to buy the shares in the index, and they can only buy shares that trade. Weighting by free float keeps the index close to what investors can actually own.
Changes in free float therefore move index weights. When a large holder sells a stake, when shares locked up after an IPO are released, or when a company issues new shares, its free float grows and its index weight rises. Funds that track the index then have to buy, and that buying often shows up in the share price around the index review date. The same logic affects the US 500, which follows the S&P 500 and reflects the weights of its largest members.
How to Increase Free Float
- A split is a stock split with a fixed split ratio. Through splits, companies increase the number of shares and reduce their price. For example, a company had 100 shares at 4 USD per share, and after a 1:2 split they own 200 shares at 2 USD
- Issue of securities is a way to increase share capital and attract investments
- Share sales by major shareholders: shares that were frozen before are released for free circulation. There might be different reasons for this
How to Reduce Free Float
- A buyback is the re-acquisition by a company of its own shares. Having amassed enough available funds, a company repurchases its shares from its shareholders and retires them. As a result, the share of major investors increases, as well as their influence on a company
- Buyout of floating securities by major shareholders to get a majority stake
- Consolidation of shares (reverse split) is a conversion of two or more shares into one of the same categories
What Free Float Value Is Considered Optimal?
The optimal Free float value for both traders and investors is in the range of 40 to 80%. Such volumes of free float shares provide some kind of protection against market fluctuations, increase the instrument's liquidity, and afford an opportunity to buy or sell an asset at any time. In other words, the higher the Free float ratio, the more liquid the instrument is and the more opportunities investors have.
Disadvantages of the Low Free Float Ratio
First of all, small or limited market demand. After buying some shares, a trader might find it difficult to sell them. There is a possibility that there won’t be a buyer in the market to acquire this asset, or its price might be very low.
Secondly, there might be sharp price fluctuations in either direction at a time of news releases, which may cause panic among market players.
Thirdly, buying a vast amount of shares by a single investor might significantly raise the price and cause disbalance. Selling a major minority shareholding can be delayed and it also might result in a price surge. In some cases, shares can’t be sold at all because there are no investors willing to buy them.
The table turns the free float ranges above into what they usually mean for a trader.
| Free float | Who usually holds the rest | What it means for a trader |
|---|---|---|
| Below 40% | Founders, the state or a strategic investor control most shares, often after a small IPO | Lower liquidity, wider spreads and sharper moves on news or on a large sale by a major holder |
| 40 to 80% | A mix of major holders and freely traded shares | Liquid enough to buy and sell easily, with smaller trading risks |
| Above 80% | Shares are spread among many funds and private investors, typical of large, long-listed companies | Deep liquidity; a single investor finds it hard to move the price |
How to Use the Free Float Ratio for Market Analysis
To begin with, the ratio provides an investor with an understanding of an instrument's liquidity. If the ratio value is 40 to 80%, an instrument is considered quite liquid and involves smaller trading-related risks.
The Free float value above 80% means that it will be difficult for jobbers and big-time investors to cause higher volatility in the market by selling/buying big amounts of shares.
A ratio value below 40% says that the majority of shares are owned by principal shareholders and they have the ability to influence share prices by unloading a lot of shares in the market. Small amounts of free float shares raise additional difficulties for selling them.
Summary
Combined with other indicators and multipliers, the Free float ratio offers traders and investors an opportunity to choose a more suitable instrument in terms of liquidity and fair market price.
Experience has proven that there is no direct correlation between liquidity and Free float, but there is an opinion that the high ratio value gives a slight edge over the low one.
FAQ
What is free float in stocks?
Free float is the part of a company's shares that anyone can buy and sell on the exchange. It excludes shares held by founders, top managers, the state, strategic investors and staff under lock-up.
How do you calculate the free float ratio?
Divide the number of freely traded shares by the total number of shares issued. If a company has 100,000 shares and 49,000 of them trade freely, the free float ratio is 49,000 / 100,000 = 0.49, or 49%.
What is a good free float percentage?
Between 40 and 80% is usually considered healthy: the stock is liquid, and no single holder can easily move the price. Below 40%, trading can be thin and prices can jump on news or on a large sale.
What is the difference between free float and market cap?
Market cap values all of a company's shares at the current price. Free float market cap values only the shares that trade freely. The gap shows how much of the company is locked with major holders.
Why does free float matter for stock indices?
Major indices weight companies by free float market cap, because index funds can only buy shares that trade. When a company's free float rises, its index weight rises too, and funds that track the index have to buy more of its shares.
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