What is Floating Stock?

The best way to ensure that the investments provide good returns and limit the losses is to have a deep understanding of the structure and operations of the stock market. One such topic is floating stock which highly affects the volatility and liquidity of the stock, making it a vital factor in protecting investments.

This article explains what floating in the stock market is through an introduction to the floating stock meaning. But first, a little about shares and the logic behind ownership.

What are shares, and who are the shareholders?

A share indicates a unit of ownership of a particular company. If you own the shares of a company, it implies that you own a percentage of the issuing company. These shares are listed on the stock exchanges through an Initial Public Offering, and investors can buy and sell them based on their current price.

If you buy the shares of a company, you become the owner of the company in the proportion of the percentage of bought shares and are deemed a shareholder. You are, then, entitled to receive a portion of the company's profit. This amount is called the dividend amount, and the company declares it as per its financial performance. The shareholders can sell these shares anytime they want to another investor.

Definition of Floating Stock?

Floating stock is defined as the number of shares that are available on the stock exchanges for trading. A floating stock represents the number of total outstanding shares remaining of a company and does not include those restricted or closely held stock. The shares represented by floating stock are called the float of a company.

A company with low floating stock sees less demand from sellers. Hence, it may be difficult for investors to find buyers or sellers for such companies. In most cases, a company’s stock with a low floating stock is a penny stock and is highly volatile than a stock with a large float. However, the floating stock of a company does not remain the same over time as the company may issue additional shares to raise funds, increasing the floating stock. Furthermore, the floating stock of a company will decrease if the company buys back the shares from the open market.

Understanding Floating Shares

Once the company becomes public, the total number of shares issued by the company in the IPO enters the secondary market. Here, they are freely available to investors, which includes numerous entities such as retail investors, non-retail investors, large financial institutions etc. When these entities buy the stock, the total outstanding stock of the company decrease with the number of stocks bought by the entities. The remaining stock that is not held by the entities is called floating stock, i.e. the stock currently available in the market for new investors to buy.

For example, if a company has 1,00,000 shares outstanding and various entities hold 70,000 shares, then the number of floating stocks would be 30,000. This number fluctuates regularly as existing investors sell the shares they hold while new investors buy the available shares. If the floating stock is very less, the stock will rise or fall just by a small volume of trading, making it highly volatile and less liquid for the investors.

Importance of Floating Stock

The floating stock is one of the most important factors of a company as it allows investors to understand the number of shares that are available for trading. If the number of floating stocks is low, investors know that the company will see limited trading activity, making the stock highly volatile and less liquid. The low number of floating stocks ensures that the investors invest only after understanding that it may be difficult for them to exit their positions, and the share price may fluctuate highly, forcing losses.

Institutional investors and big financial companies always perform prior research to identify the number of floating stocks of a company. This is because they do not want to invest their money in stocks that see less liquidity and wider bid-ask spreads. Without calculating the floating stock, institutional investors such as mutual funds, insurance companies, etc., can incur hefty losses due to the highly volatile nature of stocks with a low float.

Furthermore, as these entities invest a large sum of money, it can highly influence the share price of low float stocks as the trading activity is limited. Thus, by calculating floating stock, they identify companies with large float and invest for high liquidity and less volatility.

Calculation of Floating Stock

Floating stock does not represent the outstanding shares of a company and is calculated by the below formula:

Floating Stock = Outstanding Shares – Restricted Shares – Institution-owned Shares – ESOPs

• Outstanding Shares: The total shares issued by the company till now.
• Restricted Shares: The shares that can not be traded until the lock-in period after the Initial Public Offering is over.
• ESOPs: Employee stock ownership plan where the employees receive the shares of the company and can only be sold after the vested period is over.

For example, a company has 50,00,000 outstanding shares with 35,00,00 shares owned by institutional investors. The company's management owns 5,00,000 shares, and 3,00,000 shares are owned by the employees as ESOPs. In this case, the floating stock will be calculated as:

Floating stock = 50,00,000-35,00,000-5,00,000-3,00,000

Floating stock = 7,00,000

The role of a company in floating stock

Contradictory to investor beliefs, a company is not responsible for its floating stock. The only thing a company can control is the issue of shares that contribute to the company's outstanding shares. After the company issues additional shares or buys back the existing shares, the remaining ones enter the secondary market and start to trade on the stock exchange.

Later, the company has no way to control the number of shares bought or sold by an entity. A company’s floating stock is a secondary market function, and a company has no control over the issue. Furthermore, influencing the float by illegal means can result in fines or penalties for the company.

Limitations of Floating Stock

Although understanding floating stock is critical for investors to protect their investments, they do come with some limitations, including:

• Negative Investor Sentiment: A company with low floating stock discourages investors from investing as they feel that the company has low availability of stocks. The company may be financially strong with good business operations, but investors may avoid investing as the stock will be highly volatile with limited liquidity.
• Stock Dilution: To increase the floating stock, some companies issue additional shares even when they don’t have any need for raising capital. Such action increases the outstanding shares of the company, resulting in diluting the stock. This stock dilution is the main cause of lowering the stock's share price and may force the investors to sell their current holdings.

Final Word

Investing in a low floating stock is never a good idea as it can leave your investment searching for buyers for a long period. Furthermore, your investments will see high volatility with an increased chance of losses. Hence, you must calculate the floating stock of a company before you invest.