The Rise of Small Caps with Micro Floats

The rise of small caps stocks with micro floats seemingly never ends. Traders are seeing stocks with less than one million freely available shares and the number of stocks with small floats are increasing. I don’t think anyone is complaining, as these stocks that tend to go up the most, but there are some drawbacks to such attributes and I will discuss the pros, cons and reason why I think this has increased.

The basics

  • Stock Float: The number of shares available for public trading
  • Authorized Shares: The maximum number of shares a company can issue, predetermined at its inception
  • Outstanding Shares: The total number of shares currently held by shareholders, including both public and private ownership

Small cap traders care about what is called the stock float. The term “float” describes the common shares a company has given to the public for trading. To calculate it, you start with all the company’s outstanding shares and then remove any restricted stock, which is stock that has some kind of limitation (or lock-up period) on it when it can be sold by insiders, employees, financiers, other investors or strategic partners. So, the float represents the shares available for public trading, whereas authorized shares are the maximum number a company can issue. The authorized share count is set when the company is formed and it’s not mandatory for the company to issue all of its authorized shares. Although, this can happen overtime if the company is performing poorly.

Supply and demand

The float often can dictate how volatile the company’s stock might be on any given day. Simply due to supply and demand, if there are less freely available shares to trade, that might mean the stock could go up, or down, on any given day much more than another company even with if both are around the same price. If their float numbers are different, they will trade very different. Company A with a float of 1 million shares and 20 million outstanding shares will not trade the same as Company B with a float of 200 million and 1 billion outstanding shares.

The pandemic changed everything

Now that the basics have been laid out, I can talk about why this scenario of small floats have increased. Although the broad stock market has rebounded substantially after initially dropping in 2020, small cap stocks as measured by the index IWM, have struggled to perform. In fact, they have underperformed substantially when measured against the SPY. To be fair, most small cap stocks that traders might trade are not even included in the IWM index, but a rising tide should lift all boats. And in this case, the tide has not yet helped small caps.

Why does this matter?

Although as I type this article, investor interest in small cap stocks and the IWM index has started to increase as traders and investors look for stocks that are not as overheated, this was not always the case. Post pandemic, interest in small cap IPOs, let alone IPOs in general, was very small. Many of the small cap IPOs that debuted had extremely low floats and outstanding shares. This was simply because all the capital seemingly went into large caps and tech stocks. So, any small cap IPO barely had any interest from a capital raising perspective. This left these stocks with micro floats and no analyst coverage, due to how small they were. Additionally, it left a lot of stocks with a suspicious capital structures, such as a founder owning more than 80% of the outstanding shares, essentially making the float even smaller. As you can imagine, even if the float is small, but has a lot of different ownership from various investors, is not the same as one person owning a large percent of it. Although this might mean a stock could go up a lot, it can also go down a lot too.

In the above example, I specifically talk about IPOs, but the situation is more complex as I describe below.

Many small cap stocks may also be what is known as a SPAC or (special purpose acquisition company). These are essentially blank check companies that have no real business until they choose a merger partner and close the deal. By nature, they are extremely complex. A SPAC that has merged is called a de-spac, and now trades with a new name, stock symbol and more. These companies often trade with extremely small floats as investors decide to redeem their shares (having no interest in the merger partner) and thus, the company ends up with sometimes a float as low as 200,000. Normally, this would not be possible in an IPO, but can happen through the business combination process.

There is more! In fact, there is even another scenario that can result in a very float float stock.

Although reverse splits are not new, they have become more popular post pandemic due to how many small cap stocks have declined due to mostly issues of their own doing. Many stocks go public when they probably shouldn’t, some of them go public at a very high valuation, some are extremely bad companies and others are likely scams. Either way, in this example the stock price goes down and the company will eventually conduct a reverse split to allow the stock to continue to be traded on a higher exchange, such as the NASDAQ or NYSE. Some of these companies may do multiple reverse splits over several years and ultimately end up with a float that is very small, but often will have a very high authorized share count until the company eventually dilutes or begins to perform better.

Evolution of price action

The three scenarios mentioned above, account for many of the examples where a stock might have a very small float and it’s important to understand how this dynamic changed how they trade.

With the proliferation of micro and nano floats, stocks now can go from $7 to $500. Yes, this is a real example where a stock halted and gapped up that much in a single day due to the founder owning the majority of the shares.

Or how about a stock going from $30 to under $5 over a two day period day after what seemed like a liquidation event.

Other examples can include extremely choppy price action, such as the stock swiping up and down very easily. All of these new examples have increased the risks for traders, both who go long and short more so than ever before.

I don’t expect this to change anytime soon, as there are hundreds of small caps that have all of these attributes. Many of them have already declined 60-90%. The bright side is, maybe they begin to curl as interest increases in the small cap sector. The downside is, if they go up, many of them will sell shares and dilute into strength. At least this is a constant many traders are familiar with!

About the Author:

JohnL10, Plan and Trade

PlanandTrade.com, an American technical analysis service was founded by one of Warrior Trading’s most seasoned moderators. Known in the stock trading community as JohnL10. Today, at Plan and Trade, he offers his trading commentary and shares his technical analysis on charts by live streaming to subscribers.

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