Float Shrink

What is Float Shrink

A float shrink is a reduction in the number of a company's shares available for trading. Float shrink can occur in a number of ways: through a buyback or repurchase of a company's shares; an investor acquiring a large stake in a company; or even through a reverse split or share consolidation.

The term "float shrink," however, 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.

Understanding Float Shrink

Share buybacks and dividend payments are favored avenues for companies to reward shareholders, but the two are not mutually exclusive, and most successful companies try to reward shareholders through consistent dividend increases and regular share buybacks. A company may also repurchase shares to consolidate its holdings and achieve greater independence over its strategic direction, free from the control of investors clamoring for profits.

Float Shrink Can Help Companies Outperform the Markets

Float shrink through share buybacks can boost the performance of investment portfolios, as companies with consistent buybacks may outperform the broader market over longer periods of time. For example, in the fifteen years ending December 31, 2019, the S&P Buyback Index has returned an average of 11.5% annually, compared with 9% annually for the S&P 500 Index. This outperformance has led to renewed investor focus on float shrink and the introduction of a few float shrink exchange-traded funds (ETFs).

Note that while float shrink can also be achieved through a strategic investor's acquisition of a large stake in a company, this does not have the same positive impact as a buyback, because the total number of shares outstanding remains the same.

Example of Float Shrink

A recent example of float shrink is Apple (AAPL), which executed several share buybacks in 2018 and 2019. During the quarter ending December 28, 2019, Apple bought 70.4 million shares from investors at an average price of $284. In total, the Cupertino company spent $20 billion on the repurchase program. In January 2020, it reported results that exceeded analyst expectations. By then its stock price had jumped by 12% to $327 (before a 4-to-1 share split).

As an example of how float shrink can impact EPS, consider a company that has 50 million shares outstanding, with a float of 35 million shares. The shares are trading at $15, for a market capitalization of $750 million. The company reports net income of $50 million in a given year for an EPS of $1. In the following year, it buys back 5 million of its shares on the open market. This buyback amounts to 10 percent of its total outstanding shares, or 14.3 percent of the float (i.e. 5 million ÷ 35 million). As a result, it now has 45 million shares outstanding at the end of the second year.

Assume the company achieves net income of $55 million in the second year. While net income has increased 10 percent because of the share buyback, EPS is now at $1.22 (i.e. $55 million ÷ $45 million), an increase of 22 percent.

Recall that shares were trading at $15 at the end of the first year, for a price-earnings ratio (P/E) of 15. Assuming that the P/E ratio is unchanged at the end of the second year, the shares should be trading at $18.30 (i.e. P/E of 15 x EPS of $1.22).