Explained: What is free float and how is it important for investors?
Investors should consider the free float as an important metric when selecting stocks.
The term 'free float' refers to the company's shares that can be publicly traded and are not restricted. The term is used to describe the number of shares that are available for trading in the secondary market to the general public. Many indices calculate market capitalization based on a company's floating stock. These are known as free-float capitalization indexes.
Free float = Outstanding shares (–) locked-in shares
Therefore, if a company has 50 lakh shares outstanding in total, with 10 lakh of them locked in and held by the promoters of the company, the free float of the company would be 40 lakh.
Management decisions can cause a company's outstanding shares to decrease or increase. A company can, for example, increase its free float by selling shares in a secondary offering or by conducting a stock split. Furthermore, as restricted shares are converted to unrestricted shares, the unrestricted shares increase the free float. In contrast, a company can reduce its free float by conducting a share repurchase or a reverse stock split.
Investors should consider the free float as an important metric when selecting stocks. Stocks with a small free float are rarely invested in by institutional investors because they are more volatile than stocks with a large float. Due to the limited availability of shares in the market, stocks with a small float typically have a wider bid-ask spread and limited liquidity.
Thus, it can be concluded that the free float metric, which is frequently overlooked by investors, is an important metric that can make their journey smoother and more rideable.