Summary:
Free-float market capitalisation is a handy financial metric tool used to calculate the entire market value of the outstanding shares of a publicly traded company. This blog explains how the metric is used by traders for making informed investment decisions.
Introduction to free-float market capitalisation:
Free-float market capitalisation is a handy financial metric tool that is used by investors for making informed investment decisions. It is used to calculate the entire market value of the outstanding shares of a publicly traded company, which are available to the general public for trading. It represents the portion of a company's total market capitalisation that is not held by controlling interests, strategic investors, or other entities that may have restricted or locked-up shares.
Calculation of free-float market capitalisation:
The following is a breakdown of how free-float market capitalisation is calculated:
- Begin with the total market capitalisation of the company. This is the complete value of all the outstanding shares. This is computed by multiplying the existing market price of each share by the number of outstanding shares.
- Minus the shares that are held by insiders. This includes founders of the company, executives and other significant stakeholders who may be restricted from selling their shares because of regulations pertaining to insider trading.
- Also, minus any shares that are in possession of long-term institutional investors and strategic investors who may have restrictions with regard to the selling of their shares.
- If applicable, subtract shares that may be held by government entities.
- The shares that are remaining are those that are available to the general public for trading are those that are free-float shares.
- The free-float market capitalisation is calculated by multiplying the total number of free-float shares by the current market price.
Uses of free-float market capitalisation:
In the world of finance and investment, free-float market capitalisation is a handy financial metric which serves many important purposes. The following are some of the main uses of free-float market capitalisation:
- Investment analysis: Free-float market capitalisation is frequently used by investors to evaluate the investment potential and liquidity of the stocks of a company. The higher the free-float market cap, the better the liquidity and ease of trading those shares in the open market.
- Index calculation: Most stock market indices utilise free-float market capitalisation to evaluate the weight of individual stocks within that index. This helps to ensure that stocks that have a larger free-float market cap have a greater impact on the performance of the index.
- Portfolio construction: Managers who construct portfolios use the free-float market cap to construct portfolios that are diversified efficiently. Based on the free-float market caps of the different companies, they allocate assets to manage risk and achieve the investment objectives.
- Benchmarking: Investors and analysts use free-float market capitalisation to compare and benchmark organisations within the same sector or industry. This is handy for finding companies that are of similar size and so that their relative performance can be evaluated.
- Market cap-based investment strategies: A number of investment strategies, such as market cap-weighted and equal-weighted index funds or ETFs, are constructed based on the free-float market cap. These strategies are aimed at replicating the performance of specific sectors and market segments.
- Risk assessment: Companies that are small and have low free-float market cap are usually more susceptible to volatile price swings and price manipulation because of lower liquidity. Investors use this metric to measure the risks associated with investing in these companies.
- Mergers and acquisitions: During mergers and acquisitions, the target company's free-float market cap is the most important factor for determining the acquisition price and for evaluating the impact of the deal on the financials of the acquiring company.
- Investor relations: Organisations often monitor and provide information about their free-float market cap as part of their efforts to maintain investor relations. Potential investors are able to get information about the size of the company and its ability to accommodate new shareholders.
- Trading strategies: Investors rely on the analysis of free-float market cap to identify potential trading opportunities and trends. Stocks that have a significant free-float market tend to attract more attention from traders.
- Market research: Researchers and analysts use free-float market cap for their market studies. This helps to analyse the concentration of market power and to predict market behavior.
Summing up:
In comparison to other indicators, free-float market cap is a very versatile metric that can help with the various parts of investment decision-making, financial analysis and market-related activities. Investors are able to make informed decisions, index providers are able to create representative benchmarks and participants in the market are able to better understand the different forces that are working in the stock market. If you are planning on making investments in the stock market, the free-float market cap can be a very handy tool for financial analysis, comparing companies' sizes and evaluating their growth potential.