What Is a Float Shrink?
The term float shrink refers to a reduction in the number of a company's shares available for trading. A float shrink can occur in several ways but is most commonly associated with share buybacks, as this is a popular way for companies to return cash to shareholders.
A float shrink achieved through a share buyback also reduces the total number of shares outstanding for a company, which has a positive impact on earnings per share (EPS) and cash flow per share.
- A float shrink is a reduction in the number of a company's shares available for trade.
- The shrink can occur through share buybacks, acquisitions, or reverse splits.
- Float shrinks can help companies consolidate control.
- While a float shrink that results from a share buyback may increase shareholder value, it won't necessarily have a positive impact if it stems from an acquisition.
- Companies that consistently shrink their share numbers, tend to consistently outperform the market.
How Float Shrinks Work
A float refers to the total number of shares that a company has available for trading on the market. This group of shares includes those that investors can buy and sell on stock exchanges. This figure doesn't include any restricted stock, which are any unregistered shares that are allotted to certain entities like directors and executives.
A float can shrink when the total number of available shares drops on the market. As such, it is called a float shrink. Float shrinks can occur for any number of reasons, including:
- Share buybacks
- The acquisition of a large stake by an investor
- A reverse split or share consolidation
The most common reason, though, is the share buyback, which can boost the performance of investment portfolios, as companies with consistent buybacks may outperform the broader market over longer periods. As noted above, this method boosts a company's EPS and cash flow per share by increasing shareholder value.
For example, the S&P Buyback Index returned an average of 11.2% annually in the 15 years ending Dec. 31, 2019. This is compared to 9% annually for the S&P 500 Index. This outperformance led to renewed investor focus on float shrinks and the introduction of a few float-shrink exchange-traded funds (ETFs).
A company's float doesn't include any shorted shares. That's because these shares are simply redistributed and are not available for the public to trade.
One thing to keep in mind about float shrinks. While a share buyback may be able to have a positive impact on the company by creating shareholder value, the same principle doesn't necessarily apply when the float shrinks because of an acquisition. That's because when an investor (whether that's an individual or another company) takes a large stake in the company, the total number of shares outstanding remains the same.
Example of Float Shrink
Here's a hypothetical example to show how float shrinks work. In this case, we look at how it affects EPS.
Let's assume a company has 50 million shares outstanding with a float of 35 million shares. The shares trade at $15 for a market capitalization of $750 million. The company's net income was $50 million in a given year for an EPS of $1. In the following year, it buys back five million of its shares on the open market. This buyback amounts to 10% of its total outstanding shares, or 14.3% of the float (i.e. 5 million ÷ 35 million). As a result, it has 45 million shares outstanding at the end of the second year.
Now let's assume that the company earns a net income of $55 million in the second year. While net income increased 10% on an absolute basis, because of the share buyback, earnings on a per share basis (EPS) increased by 22%, or $55 million - $50 million = $5 million/45 million shares = $1.22 EPS vs. $1.00 in the previous reporting period.
Recall that shares traded at $15 at the end of the first year, for a price-earnings (P/E) ratio of 15. Assuming that the P/E ratio is unchanged at the end of the second year, the shares should trade at $18.30 (i.e., P/E of 15 x EPS of $1.22).
Apple (AAPL) executed several share buybacks that resulted in float shrinks—notably in 2018 and 2019. During the quarter ending Dec. 28, 2019, Apple bought 70.4 million shares from investors at an average price of $284.
The Cupertino company spent a total of $20 billion on the repurchase program. In January 2020, it reported results that exceeded analyst expectations. By then its stock price jumped by 12% to $327 (before a 4-to-1 share split).