Market capitalization is the value of the product of a company’s total number of shares (total outstanding shares) and the current market price of each share. The total shares include all the owned by the company’s officials, employees as well as the public.
For example; XYZ ltd. is a company with 10,00,000 shares with the market price Rs. 80 per share. Therefore, the market capitalization of XYZ ltd. is Rs. 8 crores.
Free-Float Method for Market Capitalization
Free-float market capitalization is the value of the product of the current market price of the shares and the total number of shares that are readily accessible in the market for trading. These shares do not include the shares which are of a locked-in type and which are closed for trading. Here, by locked-in shares, we mean those shares which are held by the promoters, owners or employees of the company (i.e. the company insiders) and are not available in the open market.
Another name for this method is float-adjusted capitalization. It should be noted that the value of free-float market capitalization will always be lesser than the value of market capitalization.
Computation of Free-Float Market Capitalization
The Formula for free-float market capitalization:
FFM Capitalization = Share Price x (Total number of shares issued–Number of shares not available for trading)
Consider a company ABC ltd with details as follows:
- Total number of shares issued = 50000 shares
- Locked-in shares = 3000 shares
- Shares held by promoters of ABC ltd = 5000 shares
- Strategic holding = 2000 shares
- Current Market Price per share = Rs. 2400
Calculations are as follows:
= Share Price x Total number of shares issued
= Rs. 2400 x 50000
= Rs. 12 crore
- Number of shares unavailable for trading
= Locked-in shares + Shares held by promoters + Strategic holding
= 3000 + 5000 + 2000
= 10000 shares
= Share Price x (Total number of shares issued – Number of shares not available for trading)
= Rs. 2400 x (50000-10000)
= Rs. 9,60,00,000
= Rs. 9.6 crore
Thus, the free-float market capitalization value is much lesser than the market capitalization value.
Why Free-Float Market Capitalization?
- Free-float market capitalization represents the true picture of the current trading scenario in the market. It is considered to be a more rational index because it only considers the shares which are available in the open market for trading.
- The free-float method of calculating market capitalization facilitates a broader-based index by minimizing the concentration of a few companies with large market capitalization values. This is because the free-float method eliminates the chances of the index data to be distorted because this method does not consider some top companies which have a huge market capitalization value but also have a significant proportion of their stock not be available in the open market for trading.
- Free-float market capitalization also succeeds in eliminating those companies which have a tiny proportion of their equities being traded in the market. The free-float method is more focused on the companies which are market-driven.
Capitalization Weighted Index in Relation with Free-Float Method
A stock market index in which the elements are weighted in accordance with the market value of the total number of shares issued is called a capitalization-weighted index, also known as a market-value weighted index.
One such version of the capitalization-weighted index is the free-float weighting. In this method, afloat factor is allotted to each share issued by the company to provide for the proportion of shares that are held open for trading in the market as opposed to the proportion of shares held closed for trading in the market.
For example, consider a company XYZ ltd with 50,000 total outstanding shares of which 40,000 shares are held publicly and 10,000 shares are held closely by the company. Therefore, 80% of the shares are held open for trading in the market and the remaining 20%, otherwise. Thus, the float factor is 0.80.
FMM Capitalization = Market Capitalization x Float Factor
With reference to the example of ABC ltd,
- Float factor = 40000/50000 = 0.80
- FFM Capitalization = Rs.12 crore x 0.80= Rs. 9.6 crore
Free-Float & Volatility
Free-float is typically inversely related to volatility in the market. This is because a larger value of free-float implies that a larger number of traders are buying and selling in the market. Conversely, a lower free-float implies that there is more volatility in the market because few traders can influence the market price significantly.
What is NIFTY Index?
Nifty is a stock index that is associated with one of the stock exchanges of India, viz. National Stock Exchange (NSE). The Nifty index represents the statistical aggregate which tells how the quantum and direction of changes happening in the stock market can be measured. It is an assemblage of 50 company’s stocks, ergo also known as Nifty 50.
Nifty Index has been trading since April of 1996 and is owned by India Index Services and Products Ltd (IISL). The index traces the behavior of the portfolio of blue-chip companies which is the largest and most liquid of Indian securities.
Calculation of NIFTY Index
The Nifty index is calculated through the free-float market capitalization methodology. The level of index indicates the float-adjusted market capitalization value of all stocks in the index relative to a base period. The methodology also accounts for constituent changes in the index and corporate actions such as stock splits, rights issuance, etc., without affecting the index value.
NIFTY Index Value = Current Market Value / Base Market Capital x Base Index Value
- Say Nifty is constituted of only 2 companies, i.e. M and N.
- M has 10000 total outstanding shares, of which 2000 are locked-in shares. The market price of the shares of M is Rs. 80. N has 20000 total outstanding shares, of which 5000 shares are held by promoters. The market price of the shares of N is Rs. 90.
- The base is year is assumed to be 1995 and the base index value to be 1000.
- Assume Market Capitalization during 1995 was Rs. 1,99,000.
M’s total market capitalization = Rs. 80 x 10000 = Rs. 8,00,000
M’s float factor = (10000-2000)/10000 = 8000/10000 = 0.80
M’s free-float market capitalization = Rs. 8,00,000 x 0.80 = Rs. 6,40,000
Similarly, N’s total market capitalization = Rs. 90 x 20000 = Rs. 18,00,000
N’s float factor = (20000-5000)/20000 = 15000/20000 = 0.75
N’s free-float market capitalization = Rs. 18,00,000 x 0.75 = Rs. 13,50,000
Total free float market capitalization of M&N = Rs.(6,40,000 + 13,50,000)
= Rs. 19,90,000
Thus, NIFTY Index = (19,90,000 x 1000)/1,99,000 = 10,000.
-By Mahek bajaj