What is Free Float Market Capitalization?
Free Float Market Capitalization is a method by which the market cap of an index’s underlying are calculated and are calculated by multiplying the price with the number of outstanding shares and does not consider the shares that are held by promoters, insiders and the government.
Brief Explanation
Free float market capitalization calculates the market capitalization of the company after taking into consideration only those shares of a company that are actively traded in the open market and are not held by the promoters or is locked-in shares in nature. Free shares are those shares that are issued by the company which are readily available and are actively traded in the market.
These shares exclude the following shareholders but are not limited to: –
- Shareholding of Promoters/founders/partners/directors
- Controlling interest
- Shares held by Private Equity Funds/Hedge funds or any other Fund
- Shares pledged to debt borrowers are they are locked-In shares in nature
- Equity held by cross-holdings
- Equity held by various Trusts are also not actively traded
- Any other 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 capitalization will always be lesser than the full capitalization method. The free float methodology has been widely adopted by most of the world’s major indexes. 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 a company XYZ with the following details –
- Oustanding Shares = 20,000 shares
- Promoter Holding = 5,000 shares
- Locked Shares with Shareholders = 2,000 shares
- Strategic holding = 1,000 shares
Current Market Price is $50 per share. Find out 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
It involves the following steps –
- Number of shares not available 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) = $50 x $12,000 = $600,000
Advantages
- The free float index represents the market sentiments more rationally and accurately as it considers only active traded shares in the market and no promoter or any shareholder holding major % can influence the market easily
- 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 the companies which have 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 only free-floating capital is taken into consideration it becomes possible to include these types of companies in the index in order which increases the ground play
- Large free-floating shares have less volatility in their shares as more shares are actively traded in the market and fewer people have the power to significantly increase or decrease the share price. On the other hand, shares with less free-float are likely to see more price volatility as it takes fewer trades to move the share price
- Globally it is considered to be the best method to use and is being used as the industry best practice. Almost all major indices of the world like the FTSE, S&P STOXX, etc are weighted under this method. The Nasdaq-100’s Exchange Traded Fund QQQ is also weighted on the free-floating basis. In India, both the NSE and BSE use the free-float method to calculate their benchmark indices Nifty and Sensex respectively and assigning weight to stocks in the index
How should investors use Free Float information?
A risk-averse investor looks to invest in the shares generally where there is large free-floating of shares which in turn results in less share price volatility. The share is actively traded which also increases the volume of share giving the investor easy exit in case of a loss. The shareholding of the promoter party is also less, therefore, giving the retail investor more voting rights and power to actively participate in the company’s initiatives and express his 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 company listed on the exchange needs to submit the shareholding pattern of the companies on a quarterly basis. This is done to determine 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 given below. A Free-float factor of say 0.55 means that only 55% of the market capitalization of the company will be considered for index calculation.
Free-Float Bands
Source:- Bse Website
To calculate the free-float market capitalization of any company in the exchange the above factors are multiplied as per the information provided by the company.
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