What is Free Float Market Capitalization?

Brief Explanation

Free float market capitalization calculates the company’s market capitalization after considering only those shares of a company that are actively traded in the open market and are not held by the promoters or locked-in shares. Free shares that the company issues are readily available and are actively exchanged in the market.

Key Takeaways

  • In the free float technique, shares held by promoters, insiders, and the government are not included in the calculation of the market capitalization of the underlying index. Instead, the price is multiplied by the number of outstanding shares.The free-float market capitalization has several advantages. Companies with huge market capitalizations or low free-floating shares can now be considered in the index’s composition, and the index’s scope under free float expands significantly. Since only the company’s free-floating capital is considered, it is conceivable to include these kinds of businesses in the index under the free-float market capitalization to broaden the playing field. The full-market capitalization technique contrasts with the free-float methodology in that it calculates market capitalization using active and dormant shares.

These shares exclude the following shareholders but are not limited to: –

  • Shareholding by promoters/founders/partners/directorsControlling interestControlling InterestA controlling interest is the shareholder’s power to speak in the corporate actions or decisions derived from possessing a considerable chunk of the company’s voting stock. However, such a stakeholder may or may not hold a significant portion of the company’s common stocks.read moreShares held by private equity funds/hedge funds or any other fundLocked-In shares pledgedShares PledgedPledged shares are shares transferred to the lender as collateral security by the company’s promoters to raise funds or take a loan for business requirements, working capital requirement, business funding, or raising funds for any new projects.read more to debt borrowers Equity held by cross-holdingsEquity held by various trusts which are not actively tradedAny additional locked-in shares which are not actively traded in the securities market.

The method is also known as float-adjusted capitalization. Under this method, the resulting market capitalizationMarket CapitalizationMarket capitalization is the market value of a company’s outstanding shares. It is computed as the product of the total number of outstanding shares and the price of each share.read more will always be lesser than the full capitalization method. The world’s major indexes have widely adopted the free-float methodology. The famous indexes which currently use the free-float method are S&P, FTSE, and MCI index.

Formula to Calculate Free Float Market Capitalization

Calculation

Let us assume that there is an XYZ company with the following details –

  • Oustanding SharesOustanding SharesOutstanding shares are the stocks available with the company’s shareholders at a given point of time after excluding the shares that the entity had repurchased. It is shown as a part of the owner’s equity in the liability side of the company’s balance sheet.read more = 20,000 sharesPromoter Holding = 5,000 sharesLocked Shares with Shareholders = 2,000 sharesStrategic holding = 1,000 shares

The current market price is $50 per share. But, first, let us determine the market capitalization and free-float market capitalization.

Market capitalization = total number of shares x current market price = $50 x 20,000 = $1000,000 = $1 million

For calculating the free-float market capitalization, follow these steps: –

  • Number of shares unavailable for trading = Promoter Holding + Locked shares with Shareholders + Strategic Holding

= 5,000 + 2,000 + 1,000 = 8,000 shares

  • Free Float Market Capitalization = $50 x (20,000 – 8,000) Free Float Market Capitalization = $50 x $12,000 Free Float Market Capitalization = $600,000

Advantages

  • The free float index represents the market sentiments more rationally and accurately. This is because it considers only actively traded shares in the market, and no promoter or shareholder holding a major percentageShareholder Holding Major percentageA majority shareholder or controlling shareholder is an individual or a corporation that owns the majority of the company’s stock (more than 50%) and therefore enjoys more voting power than other shareholders. These shareholders are in a position to influence the company’s decisions.read more– can easily influence the market.The method makes the index’s base broader as it reduces the concentration of the top companies in the index.The scope of the index under free float becomes much wider as companies with large market capitalization or low-free floating shares can now be considered in the composition of the index. Under the free-float market capitalization, since only the company’s free-floating capital is considered, it is possible to include these types of companies in the index to increase the ground play.Large free-floating shares have less volatility in their claims as more shares are actively traded in the market, and fewer people have the power to increase or decrease the share price significantly. On the other hand, claims with less free-float are likely to see more price volatility as it takes fewer trades to move the share price.It is considered the best method and is the industry’s best practice. Almost all major indices of the world, like the FTSE, S&P STOXX, etc., are weighted under this method. In addition, the NASDAQ-100’s Exchange Traded FundExchange Traded FundAn exchange-traded fund (ETF) is a security that contains many types of securities such as bonds, stocks, commodities, and so on, and that trades on the exchange like a stock, with the price fluctuating many times throughout the day when the exchange-traded fund is bought and sold on the exchange.read moreQQQ is also weighted free-floating. In India, both the NSE and BSE use the free-float method to calculate their benchmark indices – Nifty and Sensex – and assign weight to stocks in the index.

How should investors use Free Float information?

A risk-averse investor generally looks to invest in the shares with a large free-floating of claims, resulting in less share price volatility. In addition, the percentage is actively traded, increasing the volume of shares, giving the investor an easy exit in case of a loss. The shareholding of the promoter party is also less, giving the retail investorRetail InvestorA retail investor is a non-professional individual investor who tends to invest a small sum in the equities, bonds, mutual funds, exchange-traded funds, and other baskets of securities. They often take the services of online or traditional brokerage firms or advisors for investment decision-making.read more more voting rights and power to actively participate in the company’s initiatives and express their opinion and solutions to the board.

Development of Free-Float Factor in BSE Sensex (India)

In India, the Bombay Stock Exchange has developed a platform whereby each listed company must submit its shareholding patterns quarterly. It determines the free-float factor, which the exchange adjusts to the full market capitalization method. It is rounded off to the higher multiple of 5, and each company is categorized into one of the 20 bands mentioned below. A free-float factor, e.g., 0.55, means that only 55% of the company’s market capitalization will be considered for index calculations.

Free-Float Bands

Source:- Bse Website

These factors are multiplied as per the information provided by the company to calculate the free-float market capitalization of any company in the exchange.

This article is a guide to Free Float Market Capitalization. We discuss what is free-float market capitalization, the formula, and how investors can use it. You may also have a look at these articles below to learn more about valuations: – 

The total market capitalization method considers both the shares currently available as well as those presently locked in. On the other hand, the free-float system considers the shares currently available in the market.

Stocks with lesser free float come with increased fluctuation, and volatility is lower than a larger free float.

Free-float methodology tends to reflect market trends because it only considers the shares available for the trade; that is why it is used in the index calculation.

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