Free float is the number of shares held by public. A company can issue 10 million shares but the owners can hold 7 million shares. Hence, the float will be 3 million shares or 30%. This is the true number of shares available for the public to trade. The company owners are unlikely to sell their shares, hence, the float can be considered as the supply side of the company shares. Fundamental economics will tell you that price is where demand meets supply. With supply fixed, the only way for price to rise is for demand to increase.
Demand is likely to increase tremendously in the final phase of bull run. Everyone is pouring their money into the market and snatching shares at whatever price they can get. Logically, a company with a smaller float would have less supply in the market. Hence, a slight increase in demand would push up the price easily as compared to a company with a bigger float.
I ranked the following companies by the percentage free float. I randomly chose 4 blue chips and 3 penny stocks. As expected, the smaller companies with smaller float have large increment in their stock prices.
- Column 1: Company
- Column 2: Free float or the percentage of shares held by public
- Column 3: I used the highest volume recorded in 2007, which was the peak of the stock market before the Subprime Crisis and expressed in percentage of free float
- Column 4: I took the ratio of the peak volume in 2007 and the average volume for the past 3 months (before 8/8/11)
- Column 5: The percentage increase in price from 24 Jun 06 to 23 Jul 07. The dates are chosen because the latter seemed to be the peak of the market and the former was simply a year before it.
You can see that the blue chips can hardly reach 1% of free float during the last phase of bull run, which supposedly is a period of highest demand. The penny stocks generally have lower float and you can see that the % of the free float increase several folds during 2007.
All the resources you'll ever need as an investor
We've gone ahead and done the work. Compiled here are all the resources you'll need as an investor.
Law of supply and demand is clearly at work here. Less supply means it is easier to drive up price in times of high demand. It is a double edged sword as well, less supply also means it is easier to drive down price in times of low demand.