What is Free Float Market Capitalization? MCap Methodology Explained!
FREE Float Market Capitalization: As a novice investor have you ever come across terms like Market Cap (MCpap) or the free float factor. In this article, we cover what is Market cap, how the MCap is computed, What is free-float market capitalization, and why it is necessary. Keep reading to find out.
What is Market Cap or MCap?
Market Capitalisation (Mcap) gives investors the public perception of what a company is worth and is also used to further classify companies. It is calculated by multiplying all the company’s shares by the price of each stock in the market. Doing this gives us the total value of all the shares being traded in the market.
This figure gives investors an idea as to what the company is worth including its future prospects and what other investors are willing to pay for it in the present. Based on the MCap companies are further classified into –
- Large-cap companies – Rs 28,500 crore or more.
- Mid-cap companies – above Rs 8,500 crore but less than Rs 28,500 crore.
- Small-cap companies – less than Rs 8,500 crore
There are multiple ways to measure the market capitalization of a company. The two of the most commonly used methods are the total market capitalization method and free-float market capitalization. You can use TradeBrains’ portal to see the market capitalization of all the major Indian companies.
Let us have a look at how MCap is calculated in each of these methods along with examples.
Free Float Market Capitalization Method
The shares can be further classified based on their ownership. Say shares may be held by retail investors or institutional investors, promoters, government, etc. What Free-float MCap does is it only includes shares that are readily available for trading in the secondary market.
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Certain shares like those held by promoters are not freely traded in the market. The aim of this method is to distinguish between shares held for strategic control and others who invest based on the stock price.
According to the BSE, the following shares are to be excluded when computing MCap under free float:
- Shares held by founders/directors/acquirers which have a control element
- Shares held by persons/ bodies with “Controlling Interest”
- The Shares held by the Government(s) as promoters/acquirers
- Holdings through the FDI route
- Strategic stakes by private corporate bodies/ individuals
- Equity held by associate/group companies (cross-holdings)
- Equity held by Employee Welfare Trusts
- Locked-in shares and shares which would not be sold in the open market in the normal course
Therefore Free Float Mcap = (OUTSTANDING SHARES – Restricted Shares) * Price of shares in the market
For eg. ABC Ltd. has a total of 100,000 outstanding shares. Out of these 30,000 are held by the promoters. Apart from this, no other shares are restricted i.e. 70,000 shares are available to be freely traded in the market. If the shares are traded in the market at Rs. 50 it would mean that the MCap for the company under Free Float is Rs. 35,00,000. ( Rs. 50 * 70,000 shares)
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Full Market Capitalization Method
Now let us understand the full market capitalization method which will help us better understand the difference between the two.
Under this method, the capitalization is computed using the total number of shares which include both the publicly available and the shares that are privately available. So under this method, the MCap of ABC Ltd. will be Rs. 50,00,000 ( Rs. 50 *100,000 shares).
What is the Free Float Factor and How is calculated?
The free float factor gives us an idea of how many shares are freely available for trading in comparison to those total which also includes the privately held shares in the company. This gives traders and investors an idea of the number of shares that are available for trading.
Take once again the example of ABC ltd. the free float factor for the company will be 0.70. We arrive at this by dividing the shares available for trading to the public by the total shares outstanding i.e. 70,000 shares/ 100,000 shares.
Why is Free Float MCap preferred over Total MCap?
The Free Float Market Capitalization is preferred mainly because it presents a valuation that shows the total number of shares that actually affect traders and investors who are participating in the market. Rather than include shares that are privately owned and cannot be accessed by anyone.
In addition, these restricted shares don’t play a role among the demand and supply factors for setting the price in the market. This allows the free float MCap to represent the sentiments of the market more accurately. This would not be possible in the case of Total MCap where a promoter or government holding a majority can have any influence.
Free Float is considered the best method globally in all stock exchanges. In India, both the NSE and the BSE use free float for their indexes i.e. Nifty and Sensex.
Does the Free Float Market Capitalization Matter?
The Free Float Market Capitalization allows investors to differentiate companies with the smaller free-float size and those with medium and large. It is important to note that the free float MCap is inversely proportional to the volatility of the shares in the market.
Companies with a lower free float factor would mean that it is easier for traders to influence the price. Companies having a higher free float factor would show a more stable stock as it is harder for a few large trades to influence the price.
The free float factor helps investors weed out the stocks to include only those that help meet their goals. Some investors may only prefer stocks with a large free float factor as they represent less volatile stocks.
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.
Let us know your views about the post in the comments section below. If you are looking for a beginner’s guide on how to invest in the share market in India, you should check the article on our website. Happy Investing!
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Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.