You’ll need to understand several stock terminologies before getting your head around low float stocks. For starters, there are minimum requirements that companies (both private and public) must meet before getting listed on a stock exchange. Among the listing essentials is the disclosure of management, location of the business, lines of business, and the authorized equity (shares/stock).
The Meaning Behind Authorized, Treasury, and Outstanding Stock
Authorized equity means the total number of stocks that can be floated or availed to stakeholders (shareholders/traders in the stock market). A portion of the authorized shares ends up in the market in the form of an initial public offer (IPO). Upon issuance, inaugural company stake buyers hold on to the stock as an investment while others trade it on stock exchanges.
The remainder of the stock (the difference between authorized equity and issued stock) falls into three categories:
1. Private Equity
It’s an investment class, or company ownership bought directly by individual investors or an institution. The privately held stock isn’t a financial asset in public exchanges. If a private investor buys out a portion of a publicly listed company, that purchase becomes private equity as it’s no longer available in the open market. Private equity can change hands into another private investor or back to the private or public company, in which case it becomes treasury stock.
2. Treasury Stock (Also Called Treasury Shares or Reacquired Stock)
Just as the name suggests, the reacquired stock is the number of shares repurchased from shareholders by the very company that floated the IPO. The repurchase reduces the amount of issued and outstanding shares in the stock market. Treasury stock does not pay dividends, and it can be re-issued to the public in a subsequent IPO or distributed to existing shareholders through stock splits.
3. Outstanding Shares
When you sum up the total number of stocks held by a company’s shareholders, you get the total issued and outstanding stock. Outstanding shares are the financial assets of individual shareholders, institutional investors, insiders, and company employees.
In some companies, part of the authorized stock is set aside as a share option plan for permanent employees. At times, only a section of the staff gets a share plan, especially when the parent company and its subsidiaries are involved.
Stock plans contractually offering employees the option to buy a certain number of shares at a fixed price when the vesting period is over. The vesting period is the duration it takes for employees to own the stocks in the employee stock option plan exclusively.
Vesting period can be the point at which a company goes public (listing on an exchange). The vesting period can also lapse at the time an employee retires if the stock option features as part of the employee’s retirement plan package. Once the employee exercises the stock option, the shares become part of the issued and outstanding stock.
The Definition of Float Stock
The term floating refers to the issuing of stock in the primary stock markets to create an investor base in the open stock market. Issued stock is said to be outstanding and publicly traded at a bourse or over-the-counter in the secondary stock market.
To get the actual float stock, deduct the closely held stock and restricted stock from the total issued and outstanding stock. Closely held stock includes shares in possession of majority stockholders and restricted stock (shares that are only available for trade after a particular lock-up period following an IPO). An excellent example of restricted stock is the non-tradable insider shares.
After you have made the right adjustment, the resulting number of issued and outstanding stock is the float stock hence the financial phrases low and high float stocks. High float stock means a publicly held company has numerous outstanding stock available for trading. A low float stock entity has a comparatively smaller amount of issued and outstanding stock that’s publicly traded on the stock exchange.
The float stock fluctuates from time to time as changes in institutional investor share blocks occur. The execution of employee stock ownership plans, re-issuing of treasury stock, and vesting of lock-up periods reverses (reduces) a low float stock situation. Share buybacks will have the opposite effect on low float stocks.
A company can have a large number of outstanding shares and still fit the description of a low float stock. That’s because institutions and insiders can lock-up a significant amount of outstanding financial assets. And a huge company, for instance, a multinational, with a large employee base, can set aside a sizable stock option plan for its workers.
Trading Low Float Stocks
The stock market doesn’t dictate a fixed amount of outstanding stock that renders a company a low float stock. Instead, the market applies a rule of thumb. The classification of low float stocks happens based on their deviation from an upper limit of 20 million outstanding shares and lower limit 10 million outstanding shares. So, any public company with a freely tradable outstanding stock of between 10-20 million shares (or 10 to 15 percent of the total outstanding stock) gets the low float stock label.
Note that there are certain stockholders such as major shareholders and institutions who feel that low float stocks don’t suit them. They tend to shy away from holding stock positions in a low float stock company. One of the reasons for this behavior is that low float stocks usually exhibit higher spreads and extreme volatility in comparison to high float stocks.
The abnormal volatility associated with low float stocks means that stock traders expose you to more risk. Low float stocks are in short supply and will most likely than not drastically respond to any informational catalyst.
You already know that fundamental information flows efficiently in advanced markets. For low float stocks, press releases, product launches, or other news can potentially trigger sharp price spikes in both the upside and downside directions. If the news causes a price drop, a low float stock asset or portfolio can flop. But, on the flip side, an upside spike can earn you a 100 or even a 200 percent return. Low float stocks personify the good old high risk, high compounding return financial adage.
They may be low float stocks, but still, the importance of technical analysis holds. An accurate upside price prediction can help you make top dollar trading low float stocks. Be sure to watch the relative volume trades. The higher the relative volume trade, the better. Volume trade gauges the strength of the price movement over a given horizon. Also, you might want to get professional training tailor made for learners who wish to take their low float stock trading to another level.