Free Float Market Capitalisation: There are many ways to measure the size of a company.
One such way is the free float market capitalization method.
Many Indian business houses use this method to arrive at the value of an index.
What is market capitalization?
- Market capitalization, or market cap, is the outstanding number of shares multiplied by the price of each stock.
- So, for example, if the total outstanding shares of a company, ABC Ltd., is 10,000 and each share is priced at Rs. 50, then the market cap of the company stands at Rs. 5 lakhs.
- Based on the market cap, the companies are classified as large-cap, mid-cap, or small-cap.
What is free-float market capitalization?
- In the standard market cap calculation, the total number of outstanding shares will include both public and privately owned shares.
- But in a free float market cap, the valuation of the company will rely on the outstanding shares of the company that are held publicly.
- This share number will then be multiplied by the price for each share.
- Here, the shares owned by the trusts, government bodies, and promoters are ignored.
- This will indicate that the value of the free float market cap will always be lower than the actual market cap of the company.
- It is also known as float-adjusted capitalization.
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Examples of free-float market capitalization:
- Let us understand this concept better with the help of an example,
- Company A has 10,000 outstanding shares and each is priced at Rs. 20.
- Of these, 4000 shares are held publicly, whereas the remaining 6000 shares are owned privately.
- Now, we will calculate the market cap as well as the free float market cap.
- The market cap of company A is:
- 10,000 * 20 = Rs. 200,000.
- The free float market cap of company A is:
- Publicly owned shares * price of each share:
- 4000 * 20 = Rs. 80,000.
Advantages of using a free float market cap:
The following are the main advantages of using a free-float market cap:
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Presents a practical picture:
- The total market cap includes the shares that are currently available as well as those that are presently locked in.
- Whereas, the free float market cap will only consider the number of shares that are currently available in the market for trading.
- Thus, this process is more useful because it will give a true picture of the enterprise.
- This calculation process will eliminate the companies that have a minimal number of shares available for trading in the market.
- Hence, investors can also locate businesses where they can park their extra funds after buying public shares using this technique easily.
No distortion of valuation:
- The market cap of large companies can fool investors into thinking that their shares are readily available for trading, whereas the reality is just the other way round.
- With the help of a free-float market cap, broad-based indexing is possible, which will minimize the concentration of such companies with large market cap values.
Market volatility and free-float market capitalization:
- The free float market cap is inversely proportional to the volatility in the market.
- A higher free float will indicate that the investors are rapidly selling and purchasing shares.
- If the free float is low, it will indicate higher volatility.
- At this stage, the traders cannot affect the market price in a noticeable manner.
- Thus, traders mostly prefer dealing with the shares of companies that have a higher free float.
- By doing so, the traders can buy and sell shares freely without even affecting the overall price of the index.
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We hope that the above blog gives you clarity about the Free Float Market Capitalisation method.
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