There are multiple ways to measure the size of a company. Market capitalization is an important parameter which many investors consider while putting money in a company (check out our previous post in order to understand market cap in detail). Another is the free-float market capitalization. Some investors watch free float market capitalization as it gives better insight into the quality of the holding. Indian bourses generally use the free-float market capitalization method to arrive at the value of the index.
Market capitalisation is perhaps one of the most noticed pieces of information just after the price of a stock. It has a significant impact on a retail investor for making an investment decision, and is the kind of information that is a fundamental addition to your financial knowledge base.
But the question arises here is how much difference does this method make in valuing the size of a company? In today's post we will try and understand Free Float Market Capitalization better and its role in valuing the size of the company.
What is Free Float Market Capitalization?
While calculating the total market capitalization of a company, all the shares, including the ones publicly traded as well as ones held by promoters, government, or other private parties, are multiplied with the stock price. But in the free-float market capitalization, we exclude shares held by private parties like promoters, trusts ((only when they are aligned with promoters, like family endowment trusts or employee welfare trusts), or the government (in case of PSU). We only consider shares held and traded by the public and multiply them with share price to arrive at a free-float market capitalization of a company.
Suppose company XYZ has 60,000 shares trading in public and 40,000 are held by the promoters and family. Market Price of each stock is Rs. 50. Now the total market cap would be Rs.50 lakh. But the free-float market cap of the company is Rs.30 lakh. The difference between the total market cap and free-float market cap would be more pronounced in the case of companies with large promoter holdings.
How Free Float Market Capitalization affects investment?
It may not be wrong to say that the free-float market cap represents a true picture of the enterprise compared to the total market cap. One might tend to think that there is abundant liquidity just by looking at the total market cap. However, the reality may be different as the majority of shares might be privately held. And as a shareholder, this concept is quite intuitive. The free-float market capitalisation method is widely used in the making of an index.
What is the relation between Free Float Market and Volatility?
The volatility in the stock prices is inversely related to the size of the free float. Higher float implies that there is an abundant supply of stocks and traders are less likely to manipulate the prices. However, a lower float size implies that the controlling shareholders have a greater influence on the stock prices. And this is why investors are also taking note of the free float of the company before making an investment decision.
Note: Every listed company shall maintain public shareholding of at least 25%. If the public shareholding in a listed company falls below 25% at any time, such company shall bring the public shareholding to 25% within a maximum period of 12 months from the date of such fall.
What are the Advantages of considering Free-Float Market Capitalisation before investing?
1. More practical compared to Total Market Cap:
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 a company.
2. No distortion of valuation:
With the free-float market cap methodology, broad based indexing is possible, minimizing the concentration of such companies with large market cap values and low free floats.
The MCap and the free float factor are important criteria to look at while investing. In addition to this, they also have become exceptional instruments to ensure balance in investors’ portfolios and to weed out stocks. One must however carefully evaluate these factors before investing in a company. For more in-depth knowledge you can connect with ShareIndia Team, or can check expert insights on the ShareIndia Research reports.
Disclaimer: Any advice or information in the post is a general advice for education purpose only and is not responsible for generating any trading strategy for anyone, please do not trade or invest based solely on this information.