By The stock market today has a variety of investment avenues that suit the varied interests of different types of investors. Before diving head-first in stock market investments, it is imperative to understand the terminologies associated with an investment that could help you make better decisions. One such term that could guide your future investment decisions is free-float methodology in market capitalization.
Market capitalization stands for measuring the company’s outstanding shares multiplied by the price of each share. For instance, a company with 20,000 outstanding shares at Rs. 20 each will have a market capitalization of Rs. 4,00,000. In this standard calculation of market capitalization, the total number of shares, including private and public, is considered to arrive at a value. However, in free float, also known as float-adjusted capitalization, only publicly held shares are considered. Shares owned by promoters, trust and government bodies are excluded, which also means that actual market capitalization would always be higher than the free-float market capitalization value.
Free-float market capitalization is inversely proportional to market volatility. Since there are a limited number of shares, which can be bought or sold, fewer trades move the prices significantly. This is the main reason why investors prefer dealing with shares having higher free float, which, in turn, allows them to buy and sell shares without affecting the index’s overall prices.
Let’s understand through this example – ABC Ltd has 80,000 outstanding shares priced at Rs. 20 per share. Out of this, 30,000 shares are held publicly while the rest are privately owned.
- The market capitalization of ABC Ltd:
Total outstanding shares × price of each share
80,000 × Rs. 20 = Rs. 16,00,000
- Free-float market capitalization for ABC Ltd:
Publicly owned outstanding shares × price of each share
30,000 x Rs. 20 = Rs. 6,00,000
Coming to the advantages of free-float methodology over total market capitalization:
- When it comes to judging the true picture of a security, experts tend to rely on the free-float method as it considers the shares that are available for trading in the market, which represents an accurate reflection of market movements.
- Many times, companies achieve large caps, but most of their shares remain privately locked, failing to present a true picture of their shareholding pattern. Indices in the market, which are performance trackers, are influenced by either price or market capitalization. With free float, it is possible to do broad-based indexing.
- This technique could help investors in deciding the stocks to buy today by distinguishing companies whose shares are available in the market for trading.
- Free-float market capitalization can also help in determining the float factor. For example, a company has 55,000 outstanding shares, out of which 16,000 are open for trading and 39,000 are closed. Each share is priced at Rs. 43. Therefore, the proportion of shares available for trading is 16,000/55,000 = 0.29. This is the float factor, which is assigned to each share price.
Investing in the stock market could be easy if you have the right tools and guidance to navigate through it. If you do not have the bandwidth to undertake thorough research and analysis, seeking expert could be a wise choice. A financial expert can curate bespoke stock investment plans based on your appetite for risk, investment horizon, and financial goals.
Reach out to one today to make smart investment decisions!
