Market capitalisation is the measure of a company’s outstanding shares multiplied by the price of each share. For instance, a company with 25000 outstanding shares at Rs. 40 each will have a market cap of Rs. 10 lakh. The size of market capitalisation for a company enables its categorisation into small-cap, mid-cap and large-cap classes. However, free-float market capitalisation is a different concept altogether.
What is Free-Float Market Capitalisation?
In standard market capitalisation, the calculation involves determining the total number of outstanding shares, including both public and privately owned ones. However, in free-float market cap method, the valuation of a company relies only on the outstanding shares held publicly.
This share number is then multiplied with the price for each share. In this entire calculation, privately-owned shares are excluded. Therefore, shares owned by trusts, government bodies and promoters are ignored. This also indicates that the value of a free-float market capitalisation would always be lower than the company’s actual market capitalisation value.
Free-float market capitalisation is also known as float-adjusted capitalisation.
Examples of Free-Float Market Capitalisation
To understand this concept better, consider the following examples.
Mehta Textiles has 50000 outstanding shares, each priced at Rs. 28. From these, 27000 shares are held publicly, while the remaining 23000 shares are owned privately. From this data, it is possible to calculate both the market cap and the free-float market capitalisation.
- Market capitalisation for Mehta Textiles
Total outstanding shares x Price of each share
50000 x 28 = Rs. 1400000
- Free-float market capitalisation for Mehta Textiles
Publically owned outstanding shares x Price of each share
27000 x 28 = Rs. 756000
This difference is more pronounced for companies that have a large government holding. For instance, Coal India’s free-float market cap is much lower than its regular market capitalisation, since much of its shares are held privately by the Indian government.
Here is a second example to ensure proper understanding –
The National Thermal Power Corporation has 120000 outstanding shares, out of which 30000 are publicly owned. The remaining 90000 shares are held by different government entities. The price of each share is Rs. 90.
From this information, one can derive the market cap and the free-float market cap of the company.
Market capitalisation –
120000 x 90 = Rs. 10800000
Free-float market capitalisation –
30000 x 90 = Rs. 2700000
Advantages of Using Free-Float Market Capitalisation
Free-float market cap method of evaluating an index is preferred for the following reasons –
- Presents a practical picture
Total market capitalisation method considers both the shares currently available, as well as those presently locked-in. Nonetheless, the free-float system only considers the number of shares that are currently available in the market for trading. Thus, this process is a more useful metric when it comes to judging the true picture of an enterprise.
- No distortion of valuation
Market capitalisation of large-cap companies can fool investors into thinking that its shares are readily available for trading when the reality is different. Some of the businesses achieve large-cap, but most of their shares remain locked in since they are owned privately. With the free-float market cap, broad-based indexing is possible. This minimises the concentration of such companies with large market cap values.
- Market-driven methodology
This calculation process eliminates companies that only have a minimal amount of shares available for trading in the market. Therefore, investors can locate businesses where they can park their excess funds by buying public shares using this valuation technique easily.
Understanding Free-Float Factor
Another important usage of the free-float method is to determine the float factor. This factor is allotted to each share of the business to offer an idea of the shares open for trading as compared to those held closed.
For instance, a company has 35000 outstanding shares, out of which 26000 are open for trading, and 9000 are closed. Each share is priced at Rs. 53. Therefore, the proportion of shares available for trading is –
26000/35000 = 0.74
This is the float factor, which is assigned to each share price. Now, the free-float market capitalisation for this company is Rs. 1378000 (using the same method as explained previously)
Thus, free-float method capitalisation for the enterprise would be,
FFM capitalisation –
Free-float market capitalisation x float factor
Or, 1378000 x 0.74 = Rs. 1019720
Relation of Free-Float with Market Volatility
Free-float market cap is inversely proportional to the volatility in the market. Higher free-float indicates that investors are rapidly selling and purchasing shares. Similarly, if free-float is low, it indicates higher volatility. In such a stage, traders cannot affect the market prices in a noticeable manner.
This is why traders mostly prefer dealing with shares from companies that have a higher free-float. Doing so allows them to buy and sell shares freely without affecting the overall prices of the index in question.