If you have even a remote interest in the share market, you would have heard the term market capitalisation quite often. But do you know that along with market capitalization, there is also another concept of free-float market capitalization? Confused? Do not worry we have got you covered. Read on to know the meaning of market capitalization and free float market capitalization, their differences and other key details.
What is meant by market capitalization?
Market capitalization, often referred to as “market cap,” is a measure used to quantify the total value or size of a publicly traded company in the stock markets. It is calculated by multiplying the current market price of a company’s outstanding shares by the total number of shares outstanding. In simple terms, market capitalization represents the total worth of a company’s equity as determined by the stock market.
The mathematical formula to calculate market capitalization is,
Market Capitalization = Current Stock Price × Total Number of Outstanding Shares
Market cap is often categorised into different segments:
- Large-Cap – Companies with a high market cap, indicating they are usually well-established and widely recognized. These tend to have a more stable performance. The top 100 companies on the index are classified as large-cap companies.
- Mid-Cap – Companies with a medium market cap, often representing a mix of growth potential and stability. The companies ranking 101 to 250 on the index are classified as mid-cap companies
- Small-Cap – Companies with a lower market cap, are generally considered to have higher growth potential but also higher risk. Companies ranking beyond 250 on the index are classified as small-cap companies.
What is meant by Free-Float market capitalization?
Free-float market capitalization refers to the total value of a company’s outstanding shares that are available for trading in the stock market. In other words, it represents the value of a company’s shares that are not held by controlling stakeholders, promoters, or locked-in investors. Free-float market capitalization is often used to assess the true market value of a company, as it excludes shares that are not actively traded and provides a more accurate representation of the stock’s liquidity and investor interest. Stocks with a higher free-float market capitalization tend to have better liquidity and narrower bid-ask spreads, making them more attractive for short-term trading or investment.
The free-float methodology is widely recognized globally as the best way to compute equity indices. It involves calculating the index based on the free-float market capitalization of all the companies in it. To find the free-float market capitalization for these companies, specific Investability Weight Factors (IWFs) are applied to their total market capitalization. This method aims to lessen the impact of any single company’s role in the index, considering only its actual tradable shares. This reduces the influence of large promoters or strategic holdings, which are usually not tradable. This adjustment ensures that the index truly reflects investment opportunities.
The mathematical formula to calculate free-float market capitalization is,
Free-Float Market Capitalization = Current Stock Price × Number of Free-Float Shares
Number of Free-Float Shares = Total Outstanding Shares – number of shares held by promoters, strategic investors, government, or any other locked-in entities.
What are the points to consider while calculating free-float market capitalization?
When calculating free-float market capitalization, several categories of shareholdings are excluded because they are not easily traded or represent control of the company. These include,
- Shares held by company founders, directors, or those with significant control.
- Shares held by entities with controlling interest.
- Shares held by the government as promoters or through acquisitions.
- Holdings acquired through Foreign Direct Investment (FDI).
- Strategic stakes held by private corporations or individuals.
- Shares held by associated or group companies (cross-holdings).
- Shares held by Employee Welfare Trusts.
- Locked-in shares that cannot be sold in the open market under normal circumstances.
Calculating Free-Float Factor
The free-float factor is a multiplier used to adjust the total market capitalization of a company to arrive at its free-float market capitalization. For example, a free-float factor of 0.60 means that only 60% of the total market capitalization will be considered for calculation.
Entities Considered as Non-Free Float
Entities that are considered non-free float and therefore subtracted from the total shareholding to arrive at the free-float portion include:
- Promoters and their associated groups.
- Shares that are locked-in as per the Share Holding Pattern filed by the company.
- Global Depository Receipts (GDRs) held only by promoters.
What is the difference between Market Capitalization and Free Float Market Capitalization?
The key differences between market capitalization and free-float market capitalization are tabled hereunder.
What is preferable between the two?
Market capitalization and free-float market capitalization are important concepts to understand the potential size of the company as well as the true market value of the company. There is no standard answer to the question of preference between the two as they both serve different purposes. Free-float market capitalization is often considered more accurate for assessing a company’s true market value, especially in cases where significant portions of shares are held by insiders and not available for trading. On the other hand, regular market capitalization can still be useful for understanding a company’s overall size and potential influence, but it might not fully reflect its actual tradable value.
Similarly, from an investor’s perspective, free-float market capitalization is generally preferable due to its accuracy in investment assessment and alignment with liquidity considerations. For companies listed on a stock exchange, free-float market capitalization offers benefits in attracting investors, accurately reflecting their value, and potentially leading to better representation in indices. However, both metrics have their place and can provide valuable insights depending on the context.
Market capitalization or full market capitalization is broadly used to determine the categorization of a company on an index while free-float market capitalization is used to represent the truer picture of a company as compared to its full market capitalization. These concepts are crucial in understanding the valuation and performance of the company as well as helping investors make suitable investment decisions.
We hope this blog was able to provide a better understanding of these concepts and thereby help you in shaping your portfolio. Let us know if you have any questions related to this concept or need further information on the same.
Till then Happy Reading!