Free Float Market Capitalization

Market Capitalization determines the valuation of a company by multiplying its outstanding shares by the price of each share. While calculating the market cap of a company, both public and privately owned shares are included but this is not the same with free float method as the valuation completely relies upon the outstanding shares that are owned by the public. The blog will enlighten the details about free float market cap by stating the facts and theories associated with it.

What is free float market capitalization?

In free float, only those shares are taken into account which are held by the public, shares owned by promoters, insiders, and the government are not included in this technique. The free float shares are actively traded in the open market and are readily available in the market when a company issues them.

To calculate free float strategy, shares that are privately owned must be deducted from the total outstanding shares. Hence, the formula to calculate free float market capitalization is:

Current Market Price * (Total Number of Shares – Locked Shares) = Free Float Market Capitalization

Let’s understand this with an example: If the outstanding shares of a company ‘A’ are 50000 in which 10000 are held by the insiders and 5000 shares are held by the government then the balance of shares are available in the market for trading which is 35000 shares. Let say the market price of each share is Rs 30 per share then free float market capitalization would be 35000*30 = 1050000.

Pros of Free Float Market Capitalization

Investors have several benefits of identifying free-float market cap as it helps them to ascertain the true value of a company. Investors gain insights about the shares available for trading in the market to execute their trading strategies. It represents the company in a better way by not including the shares held by the promoters. So the actual price is revealed in the indices as well as ETFs which allow investors to gain the true position of the company. Let’s know about the main advantages of free float market capitalization.

Actual Market Value

Using the free float method helps to determine the true market value of a company as it only includes the shares that are readily available for trading in the market. Investors can have true information about the market capitalization of a company based on the shares that are owned by the public. Through this method, actual value is revealed as it does not include shares that are privately owned.

Market-driven Concept

In this calculation method, the companies that consist of fewer amounts of shares available in the market for the purpose of trading are eliminated. Investors have the benefit to identify businesses where they can invest their amount with the help of this valuation method easily. The method is easily adaptable to the market conditions for investors.

Enhanced Liquidity

The companies can enhance their liquidity by increasing the number of shares for trading in the market. Investors have the benefit of buying and selling their shares wherein actual fluctuations in the share prices represents the true value of the company which increases its authenticity.

Aligned with Investor Interests

Investors are aligned toward the companies that have a large number of free float shares in the market. If a company has more shares that are locked in that means held by the insiders of the company then it is possible that there could be inappropriate movement in the prices of shares.

Facilitates Comparison

Using the free float method allows investors to efficiently compare companies for their benchmarking. Investors can make comparisons on the companies based on the shares available for trading in the market.

What is the importance of Free Float Market Capitalization?

Free-Float shares are required to leverage market liquidity and investors participation. It contributes towards increased liquidity of a company’s assets. Liquidity attracts investors towards a company’s stock as it helps to maintain an orderly market. Effective trading of assets because of liquidity allows investors to make a simple exit in case of losses. If there are a large number of free floating shares then there are less chances of volatility in the price. As a result of this, the share price cannot take a U-turn immediately.

This method has a vital role to classify a company as a mid-cap, small-cap or large cap. A company’s actual insights can be taken such as about its size and market value helping the investors to make informed decisions.

Also Read: Floating Stocks

How market volatility is impacted through the free-float method?

Investor’s behavior is impacted as the free-float market-cap affects the market volatility. Market is inversely proportional to free-float as  higher free floating shares represents a less volatile market and the market becomes more stable in contrast to this lower free float levels represents a higher market volatility. A limited supply of shares can result in major price fluctuations as it reduces investor’s confidence. On the other hand, when the supply is abundant then investors actively buy or sell the assets without making drastic changes in the prices.

Investors can effectively identify the risks associated when investing in specific stocks or indices. Identifying free float levels is essential for investors to determine the price action and make informed decisions. Investors majorly prefer to buy or sell assets of the companies which have higher free-float levels to conduct smooth transactions.

Risks of Free Float Market Capitalization

There are several benefits of using this method for investors to make their trading positions; however, there are certain disadvantages as well. Investors are not attracted towards companies with a small number of free float market shares.

Increased market manipulation

The companies that have small free-floating shares are more prone towards market manipulation as the stock that are not liquid or held by promoters can be easily manipulated. The manipulation can lead to artificial price movements that do not reveal the actual valuation of the company making it difficult for the investors to make informed decisions.

Limited Institutional Interest

Large institutions such as mutual funds, pension funds, or investors prefer stocks that provide large free-float shares. They are attracted towards companies offering a large free float as it offers higher liquidity and makes it easy to enter and exit the positions.

Wrapping it up

The fundamental concept of free float market capitalization measures a company’s market value by identifying publicly owned shares. Investors can efficiently navigate the amount of assets that are actually available for trading. They can make strategic decisions by determining the market volatility and shape their portfolios through managing the dynamics.

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