What is the free-float methodology?
The free-float approach calculates the market capitalization of underlying firms in a stock market index. The free-float technique calculates market capitalization by multiplying the equity price by the number of accessible shares.
Unlike the full-market capitalization method, the free-float technique eliminates locked-in shares held by insiders, promoters, and governments.
Knowing Free-Float Methodology
Some call free-float capitalization float-adjusted capitalization. Some analysts believe the free-float technique is superior to the full-market capitalization method for estimating market capitalization.
A company’s stock issuance plan shares make up its total market capitalization. Company stock option compensation programs typically provide unexercised stock to insiders.
Besides promoters, governments can possess unexercised stock. Total market capitalization weighting is not often used in indexes because companies have different goals when they give out stock options and exercisable shares, which would change the way returns work.
The free-float approach better represents market fluctuations and actively traded equities. Free-float market capitalization is lower than the entire market capitalization.
Because it solely considers tradeable shares, a free-float index tends to mirror market developments. The index becomes more diverse by reducing the concentration of the top few firms.
Free-Float Market Capitalization Calculation
Methodology for free-float calculation:
FFM = Share Price x (Number of Shares Issued – Locked-In Shares)
Many global indexes use free-float. The S&P 500, MSCI World Index, and FTSE 100 utilize it.
A correlation exists between the free-float technique and volatility. The quantity of free-floating corporate shares inversely affects volatility. A higher free float lowers stock volatility because more traders purchase and sell shares.
A lower free float increases volatility since fewer trades impact the market, and there are fewer shares to buy and sell. Institutional investors choose trading businesses with a more extensive free float for their ability to trade more shares without significantly affecting the price.
Market-Capitalization-Weighted vs. Price
Market index weights often reflect price or market cap. Both methods evaluate index performance based on stock weighting types. The most frequent index-weighting approach is market capitalization. The S&P 500 Index is the top capitalization-weighted index in the US.
An index’s weighting technique significantly impacts its performance. Price-weighted indexes calculate index returns by dividing stock returns by price.
Price-weighted indices provide equities with higher prices with a more significant weighting and impact index performance (independent of market size). Pricing and capitalization-weighted indices differ significantly according to their index methodologies.
Price-weighted indices are rare in trading. One of the few price-weighted indices in the market is the Dow Jones Industrial Average (DJIA).
Free-Float Methodology Example
Imagine ABC stock trading at $100 with 125,000 shares. Large institutional investors and firm management hold 25,000 shares, preventing trade. ABC’s market valuation is $10 million using free-float: 100 x 100,000 shares available for trading.
How do you calculate a free float?
Free float is a company’s outstanding shares less its restricted shares. Multiply the free-float amount by the share price to find the company’s market capitalization.
The S&P 500 Index: Free Float?
Yes, the S&P 500 Index tracks free-float. The market caps of all S&P 500 businesses are free-floating, meaning only public trading shares are considered.
How do you calculate the market cap?
Multiplying a company’s outstanding shares by its share price gives its market cap. The market valuation of a corporation with 50,000 shares and a $10 share price is $500,000.
Bottom Line
The free-float approach calculates a company’s market worth by eliminating locked-in shares. Index providers utilize it to represent a company’s trading shares better.
Conclusion
- The free-float approach calculates the stock market index underlying company market capitalization.
- Multiplying the equity price by the number of available shares yields a company’s market capitalization.
- Unlike the free-float method, the full-market capitalization technique considers active and inactive shares.
- Insiders, promoters, and governments hold locked-in shares, which the free-float technique excludes.
