Original question: In the article “do you use a wide screen to filter for quality” one of the filter criteria is “Shares/float ratio <20”. How is this calculated and why is it important?
Market cap is calculated by multiplying the price with the total amount of oustanding shares. The float is the amount of shares the company makes available on the open market. If this float is small compared to the outstanding shares it has an influence on how the stock “behaves” in the market.
Example: Company A is trading at 10 $/shares and the total outstanding shares are 100M. As a result the market cap is 100M shares multiplied by 10 $/share = 1B USD market cap.
A 1B dollar company with 100M shares provides a high liquidity for orderly trading in the markets.
Now imagine that from those 100M shares only 1M are available on the open market (1M share float). Now the company has a share/float ratio of 100M/1M= 100 with supply/demand dynamics based on only 1M shares. So the “effective market cap” is 1M shares multiplied by 10$/share ) = 10M efffective market cap.
The stock of the same 1B dollar company suddenly behaves as a 10M dollar micro cap compared to a liquid 1B dollar small/mid cap stock.
When the float is low the company can also suddenly dilute the stock by increasing the float thus killing any potential price advance momentum. Some dilution is fine and most high potential IPOs can handle a reasonable secondary offering quite well. But if the float is only a fraction of the shares you simply don’t have the “quality” you think you have based on the normally calculated market cap.
A share/float ratio < 20 is appropriate to filter out the low float junk which is prone to pump & dump schemes and dilution. The best stocks have a share/float ratio < 2