Seize a Competitive Advantage – Or Don't Compete!

Low Float Stocks – What Investors and Traders Need To Know

What Are Low Float Stocks?

Low Float StocksLow float stocks are from companies with fewer shares in circulation leaving only a tiny percentage of the stock available for public trading.

The float in a stock refers to the number of shares of a certain stock that are available for trading. Low float stocks have a small number of shares. You can derive the float in stock by deducting closely-held and restricted shares from a company’s total outstanding shares. Insiders, significant shareholders, and staff typically own the closely held shares. Insider shares cannot be traded due to a temporary restriction. For example, the lock-up period following an initial public offering (IPO). A stock with a smaller float will be more volatile than one with a larger float. This is because, with fewer shares available, finding a buyer or seller may be more difficult. This results in wider spreads and, in many cases, decreased volume.

Low Float Stocks – A Closer Look

A firm may have a significant number of outstanding shares but just a small amount of floating stock. For example, consider a corporation that has 100 million shares in circulation. However, large institutions may own half or 50 million shares in their investment portfolios. Management and insiders may own another 20 percent or 20 million shares.  Finally, the employee stock option plan (ESOP) controls 15 percent or 15 million shares. Thus, the floating stock is just 15 million shares or 15% of the original 100 million outstanding shares.

The amount of a company’s floating stock is dynamic and may fluctuate over time. This can happen for a number of reasons. For instance, a corporation may sell additional shares to raise additional capital, increasing the floating stock. Also, when restricted or closely held shares become available, the floating stock rises as well. On the other hand, if a corporation decides to conduct a share repurchase, the number of outstanding shares decreases. In this instance, the floating share percentage of outstanding stock will decrease as well.

High Float vs. Low Float Stocks

Depending on your investment objectives, a high stock float might be advantageous.  This is because it provides more liquidity and tends to reduce share price volatility. Traders find it considerably more difficult to manipulate or otherwise disturb the share price of a firm with a large float than one with a small float.

  • High float stocks – The great majority of a company’s total outstanding shares can be exchanged freely. Many S&P 500 firms are examples of this.  They tend to have highly dispersed share ownership with insiders often holding tiny interests in the corporation. In general, the longer a company’s stock has been publicly traded, the more freely its stock will float.
  • Low float stocks – Insiders tend to control a large portion of the total outstanding stock. A low float is not always a bad thing for a company. In reality, it can be a sign of alignment between insiders and their public stockholders. Some investors prefer to invest in businesses where the founder or family member controls the company. Each trader has different preferences for float percentage.  Commonly, the preferred range is 10 to 40%.

Low Float Stocks – Why Float Matters 

The float of a firm’s stock is an important consideration for investors.  It reveals how many shares are genuinely available for purchase and sale by the general investing public. The level of float has an impact on active trading. Investors may find it difficult to enter or exit positions in stocks or securities with minimal float. Because there are fewer shares to trade, institutional investors may frequently avoid trading in businesses with lower floats.  Ultimately, this results in less liquidity and higher bid-ask spreads. For stability, institutional investors like mutual funds, pension funds, and insurance firms will want to invest in companies with a greater float. Large companies with significant float mean their substantial acquisitions will have less of an influence on the share price.

However, large institutions do not retain stocks indefinitely. The share of institutional ownership changes on a regular basis, albeit not usually significantly. Dropping institutional ownership combined with a falling share price could indicate that institutions are liquidating their holdings. Increased institutional ownership indicates that institutions are amassing shares. A firm is not responsible for how floating public shares are traded.  Rather, this is a function of the secondary market. As a result, shares purchased, sold, or even shorted by investors have no effect on the float.  This is because they do not modify the number of shares available for trade. They simply signify a share redistribution. Similarly, the creation and trading of stock options has no effect on the float.

Are Low Float Stocks a Good Investment?

Liquidity is the key reason why investors care about float. If the share float is low, there may be periods when there aren’t enough shares in the market.  The result can manifest as high price volatility. When compared to traditional high-float stocks, low-float share values can soar when demand is high.  Conversely, they can drop precipitously when demand is low.

Moreover, smaller floats are prone to abrupt price swings due to news affecting a company.  This might be news releases about finances, product popularity, and other events that can influence demand. This type of volatility can give opportunities to day traders.  These are investors who purchase and sell stocks quickly in order to make money fast.  However, it is not often compatible with long-term, buy-and-hold investment strategies. Because the value of low float stocks can be so volatile, investing in them might carry significant risk. Furthermore, low float stocks are in limited supply, making it harder to buy or sell them. As a result, the bid-ask spread may be substantially wider than with a high-float stock.

Stock Manipulation and Float

Unscrupulous promoters may attempt to exploit a stock with a low float.  This is in order to induce fast price movement in that security. When the number of tradeable shares is low, it is considerably easier for a stock promotion or other such coordinated effort to succeed. A series of remarks on a social media site or forum, for example, may have a significantly greater impact on a stock where only a small percentage of its shares are openly traded.

Consider a company with a free float of 10 million shares at $10 per share. It would require $10 million to purchase 10% of the stock’s free float.  Further, such a purchase would most likely not generate too much fluctuation in the underlying stock price. However, consider the same company with only 1 million of its 10 million shares accessible in the free float.  The same $10 million purchase would buy up the entire free float of that company.  This would cause a massive disruption in the underlying security’s price. A corporation with a high float is far less vulnerable to pump and dump tactics and other unethical manipulation. A company that is tightly held by insiders or that has recently completed an IPO or SPAC deal could be more vulnerable to this type of unethical behavior.

Low Float Stocks – Example

As of May 2022, Microsoft Corporation (MFST) had 7.48 billion shares outstanding. Of this, 0.07% were held by insiders. 72.10% were held by large institutions. As a result, a total of 72.10% or 5.39 billion shares were likely not available for public trading. The floating stock is therefore 2.09 billion shares (7.48 – 5.39) or 27.9%.

Bottom Line

The great majority of investors are unconcerned about stock float. Particularly, for those who have a well-diversified investment portfolio or have purchased an index-linked ETF.  In those cases, the float of any individual stock will have little effect on overall performance. The same is true for investors who purchase a single stock with the intention of holding it for an extended period of time. Although float might enhance short-term volatility, it is not a primary driver of firm value. This is defined by the company’s quality and the product’s market relevance.

The traders that float may affect the most are daytraders and those who quickly and frequently trade equities. If a stock has a low float, it may experience considerable volatility over a shorter period of time.  Day traders in particular might want to exploit this. However, low trading volumes can sometimes result in wider bid-ask spreads. This is the gap between the market price at which investors can sell their shares and the market price at which they can buy them.

Up Next: Is Plaid Safe?

Is Plaid SafeIs Plaid safe? Plaid is a reputable company handling sensitive financial data. However, Plaid recently paid $58 million to settle customers’ privacy complaints.

Manually integrating your bank account information into each financial services app is a nuisance, to say the least. Conveniently, there are FinTech companies such as Plaid that can do this for you. If you use financial services such as Venmo, American Express, Upstart, or Robinhood, you already utilize Plaid, you just may not have known it. Plaid authenticates your financial information, allowing businesses to securely send critical information. You enter your information once and Plaid connects your bank account data to other software and financial applications. However, customers want to know how any software that accesses sensitive financial data is using their information. Furthermore, they want reassurance that their information, data, and money are safe. This begs the question, “Is Plaid safe to use?”

Leave a comment

Your email address will not be published.