Embarking on a journey into the intricacies of financial markets requires a nuanced understanding of key concepts, and one such fundamental aspect is free float market capitalisation. In this blog, we delve into the essence of free float market capitalisation, unravelling its significance in the world of investments. As we navigate through the intricacies of this concept, we aim to demystify the term, elucidating its role in market dynamics and its impact on investors. Whether you are a seasoned investor or just stepping into the realm of finance, this exploration serves as a comprehensive guide to grasping the essence of free float market capitalisation.
Market capitalisation, often referred to as market cap, is a key metric that quantifies the total value of a company’s outstanding shares of stock. It is calculated by multiplying the current market price per share by the total number of outstanding shares. Market capitalisation provides investors with insights into a company’s size, indicating its relative standing in the financial markets. Companies are generally categorised as large-cap, mid-cap, or small-cap based on their market capitalisation. This metric is fundamental for investors assessing the scale and potential risks and rewards associated with investing in a particular stock or company.
While calculating the total market capitalisation 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 by the stock price. But in the free float market capitalisation, 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 the case of PSU) are excluded. Only those shares that are held and traded by the public are considered, which is multiplied by the share price to arrive at a free float market capitalisation of a company.
Consider company XYZ with 60,000 publicly traded shares, while 40,000 are held by promoters and family members. With a market price of ₹50 per stock, the total market capitalisation amounts to ₹50 lakh. However, the free float market capitalisation, accounting only for publicly traded shares, is ₹30 lakh. This distinction becomes more evident in companies with substantial promoter holdings.
- Free float market capitalisation plays a crucial role in shaping investment strategies by offering a more accurate representation of a company’s market value compared to total market capitalisation.
- It serves as a key indicator of true liquidity, considering only publicly traded shares and providing valuable insights into the stock’s actual tradability.
- This distinction becomes pivotal when a significant portion of shares is privately held, impacting the perceived liquidity and investment attractiveness.
- Shareholders find this metric intuitive, and it holds particular significance in index construction, reflecting its influence on benchmarking and investment analysis within the financial markets.
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. This is why investors have begun to take note of the free float of the company before making an investment decision.
Note: Every listed company shall maintain a 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.
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.
No Distortion of Valuation
With the free float market cap methodology, broad-based indexing is possible, thus minimising the concentration of such companies with large market cap values and low free floats.
Free float market capitalisation is a fundamental concept in the financial landscape, offering a precise measure of a company’s market value by considering only publicly traded shares. This metric plays a crucial role in investment decision-making, providing a more accurate representation of liquidity and influencing strategies. As investors navigate the complexities of financial markets, understanding the nuances of free float market capitalisation becomes paramount for informed and strategic decision-making, shaping the dynamics of portfolios and investment outcomes.
Frequently Asked Questions (FAQs)
It is crucial for investors as it reflects the actual tradable shares, offering insights into liquidity, investment attractiveness, and a more precise representation of a company’s market value.
ETFs and mutual funds use free float market capitalisation as a key criterion for stock selection, ensuring that the selected stocks accurately represent the market’s tradable portion.
Free float market capitalisation provides a more realistic measure of a company’s market value by excluding shares that are not available for public trading, offering a clearer picture for investors.