What Is Free-Float Methodology?
The free-float methodology is a method of calculating the market capitalization of a stock market index's underlying companies. With the free-float methodology, market capitalization is calculated by taking the equity's price and multiplying it by the number of shares promptly accessible in the market.
As opposed to using the shares in general (both active and inactive shares), just like with the full-market capitalization method, the free-float method bars locked-in shares, for example, those held by insiders, advertisers, and states.
Understanding Free-Float Methodology
The free-float methodology is sometimes alluded to as float-adjusted capitalization. According to certain specialists, the free-float method is viewed as a better approach to calculating market capitalization (rather than the full-market capitalization method, for instance).
Full-market capitalization includes every one of the shares given by a company through its stock issuance plan. Companies frequently issue unexercised stock to insiders through stock option compensation plans. Different holders of unexercised stock can include advertisers and states. Full market capitalization weighting for indexes is rarely utilized and would essentially change the return dynamic of an index since companies have different levels of strategic plans in place for issuing stock options and exercisable shares.
The free-float methodology is generally remembered to give a more accurate impression of market developments and stocks actively accessible for trading in the market. While using a free-float methodology, the resulting market capitalization is more modest than what might result from a full market capitalization method.
An index that utilizes a free-float methodology will in general reflect market trends since it just thinks about the shares that are accessible for trade. It likewise makes the index more broad-based in light of the fact that it diminishes the concentration of the main few companies in the index.
Instructions to Calculate Market Capitalization Using the Free-Float Method
Free-float methodology is calculated as follows:
FFM = Share Price x (Number of Shares Issued - Locked-In Shares)
The free-float methodology has been adopted by a lot of people of the world's major indexes. It is utilized by the S&P 500 Index, by Morgan Stanley Capital International (MSCI) World Index, and by the Financial Times Stock Exchange Group (FTSE) 100 Index.
There is likewise a relationship between free-float methodology and volatility. The number of free-floating shares of a company is inversely corresponded to volatility. Regularly, a larger free-float means that the stock's volatility was lower since there are more traders buying and selling the shares. That means that a more modest free-float compares to higher volatility (since less trades move the price essentially and there are a limited amount of shares accessible to be bought or potentially sold). Most institutional investors favor trading companies with a larger free-float since they can buy or sell a big number of shares without having a big impact on the price.
Price-Weighted versus Market-Capitalization-Weighted
Indexes in the market are typically weighted by one or the other price or market capitalization. The two methodologies gauge the returns of the indexes' individual stocks by their separate weighting types. Market capitalization weighting is the most common index-weighting methodology. The leading capitalization-weighted index in the United States is the S&P 500 Index.
The type of weighting methodology utilized by an index altogether influences the index's overall returns. Price-weighted indexes ascertain the returns of an index by weighing the individual stock returns of the index by their price levels. In a price-weighted index, stocks with a higher price receive a higher weighting and, hence, have more influence on the returns of the index (no matter what their market capitalizations). Price-weighted indexes versus capitalization-weighted indexes fluctuate impressively due to their index methodology.
In the trading market, not very many indexes are price-weighted. The Dow Jones Industrial Average (DJIA) is an illustration of one of only a handful of exceptional price-weighted indexes in the market.
Illustration of Free-Float Methodology
Assume that stock ABC is trading at $100 and has 125,000 shares in total. Out of this amount, 25,000 shares are locked-in (meaning that they are held by large institutional investors and company management and are not accessible for trading). Using the free-float methodology, ABC's market capitalization is 100 x 100,000 (total number of shares accessible for trading) = $10 million.
- Free-float methodology is a method of calculating the market capitalization of a stock market index's underlying companies.
- The free-float methodology can be diverged from the full-market capitalization method, which takes into its calculation both active and inactive shares while determining market capitalization.
- The free-float method bars locked-in shares, for example, those held by insiders, advertisers, and states.
- Using this methodology, the market capitalization of a company is calculated by taking the value's price and multiplying it by the number of shares promptly accessible in the market.