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Explore how free-float market capitalisation plays a crucial role in the construction of stock indices and why it offers a more realistic picture of market performance.
Market capitalisation is a widely used measure to understand a company's size, but when it comes to building stock indices that reflect real market dynamics, free-float market capitalisation becomes vital. This method, which considers only the shares available for public trading, is now the global standard for index construction.
Free-float market capitalisation refers to the total market value of a company’s shares that are readily available for trading in the public market. It excludes shares held by promoters, government entities, or insiders that are not typically traded.
AlphaTech Ltd., a company listed on the stock exchange. It has a total of 100 crore outstanding shares, and its current share price is ₹200.
However, not all shares are available for public trading. Around 30% of the shares are held by promoters and long-term strategic investors, leaving only 70% as free-float shares (i.e., available for trading by the public).
To calculate the free-float market capitalisation, we use only the publicly traded shares:
Free-float Market Cap = Share Price × Number of Free-float Shares
= ₹200 × (100 crore × 0.70)
= ₹200 × 70 crore
= ₹14,000 crores
So, the free-float market cap of AlphaTech Ltd. is ₹14,000 crores. This figure is crucial for inclusion in market indices like Nifty or Sensex and helps measure the company’s actual liquidity in the market.
Focuses only on shares available for public trading, giving a more realistic picture of a stock's market presence.
Reduces the influence of companies with large promoter holdings but low public float, ensuring balanced index composition.
Companies with higher public shareholding are more likely to maintain transparency and governance standards.
Major indices (like Nifty & Sensex) use the free-float method to provide a fair representation of investable market value.
Helps in comparing companies based on the portion of shares that can actually be traded, rather than total shares issued.
Investors can rely on indices built using free-float as they reflect true market dynamics and investability.
Stock indices serve as a reflection of market sentiment and economic performance. For them to be accurate, they must represent only those shares that are actively traded.
Free-float methodology ensures that indices track the prices of shares actually influencing the market. By filtering out locked-in or strategic shares, it reflects true liquidity and market interest.
If full market cap were used, companies with large promoter holdings would dominate the index, even if their traded volumes are low. Free-float caps their influence proportionately.
India has embraced the free-float methodology for its primary indices, ensuring better market alignment.
Both indices use free-float market capitalisation for inclusion and weightage. They undergo semi-annual reviews to rebalance based on float changes.
If Company A increases its public shareholding through an offer-for-sale, its free-float increases, leading to a higher weight in the index. Conversely, a buyback reduces float and hence its index weight.
Free-float market capitalisation offers a more realistic, tradeable snapshot of market activity and has become the cornerstone of modern index construction. It ensures indices reflect public sentiment and liquidity, enhancing investor confidence and portfolio precision.
This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.
Sources
Securities and Exchange Board of India (SEBI): https://www.sebi.gov.in/
National Stock Exchange (NSE): https://www.nseindia.com/
Bombay Stock Exchange (BSE): https://www.bseindia.com/
MSCI Index Methodology: https://www.msci.com/our-solutions/indexes/index-methodology
FTSE Russell: https://www.ftserussell.com
Investopedia: https://www.investopedia.com
Free-float counts only the publicly tradable shares, whereas full market cap includes all outstanding shares.
It helps indices reflect actual market trends and liquidity, offering a more accurate benchmark.
It is the ratio of freely traded shares to total outstanding shares, typically disclosed in quarterly filings.
Yes, due to events like share buybacks, public offerings, or promoter stake changes.
