Freefloat is a term that resonates deeply within the financial markets, acting as a crucial metric for investors, analysts, and market participants alike. It provides valuable insights into a company's stock availability and its potential volatility and liquidity in the market.
This article focuses on the meaning of freefloat, its calculation method, and its significant impact on stock indices and market capitalization. We'll also explore the advantages and disadvantages of freefloat, offering an understanding that aids in making informed investment decisions.
Curious about Forex trading? Time to take action!
Use our free demo account to practise trading 70+ different Forex pairs without risking real cash
Freefloat meaning & example
Freefloat, a key metric in the stock market, indicates the number of shares of a company that are readily available for trading by the general public. This figure excludes shares held by stakeholders, promoters, and governments, which are not freely traded in the open market. Understanding freefloat is vital for investors as it provides insights into a stock's liquidity and potential volatility.
Example: Consider the hypothetical scenario of SolarTech Innovations, a leading company in the renewable energy sector. SolarTech Innovations has issued a total of 10 million shares. However, not all these shares are available for public trading. The breakdown is as follows:
- Total shares issued: 10 million shares
- Insider-held shares: 2 million shares (held by company executives and board members, with restrictions on selling)
- Government-held shares: 1 million shares (held as part of a strategic investment by the government, with selling restrictions)
- Employee stock option plan (ESOP) shares: 500,000 shares (allocated to employees, but not yet vested or available for sale)
To calculate SolarTech Innovations' freefloat, we subtract the total restricted shares from the total issued shares:
Freefloat = Total issued shares − (Insider-held shares + Government-held shares + ESOP shares)
Freefloat = 10,000,000 − ( 2,000,000 + 1,000,000 + 500,000 )
Freefloat = 6,500,000 shares
Therefore, SolarTech Innovations' freefloat consists of 6.5 million shares, representing the portion of the company's equity that is freely tradable in the stock market. This figure is vital for investors and analysts, as it impacts the company's liquidity, market volatility, and its weighting in market indices.
A higher freefloat typically indicates greater liquidity, allowing investors to buy and sell shares with less impact on the stock's price. Conversely, a lower freefloat might lead to higher volatility due to the limited number of shares available for trading.
This example illustrates the importance of free float in evaluating a company's stock for investment. By understanding the components that restrict certain shares from being freely traded, investors can make more informed decisions about the liquidity and potential price movements of a stock.
Freefloat calculation
The calculation of freefloat is straightforward yet vital for understanding market dynamics. It involves subtracting the number of restricted shares from the total number of outstanding shares. The formula is:
Freefloat = total outstanding shares − restricted shares
This calculation helps in assessing a company's market liquidity and is often used by stock exchanges to determine the weight of a stock in indices.
Impact of freefloat on indices and market capitalization
The freefloat of a company not only influences its stock's liquidity and volatility but also plays a significant role in its market capitalization and positioning within market indices. Market capitalization is calculated as the share price multiplied by the total number of shares outstanding.
However, for index calculation, many stock indices use free-float-adjusted market capitalization to better reflect the market dynamics.
Market capitalization vs. free-float market capitalization:
- Traditional market capitalization: Calculated using the total number of shares outstanding.
- Free-float market capitalization: Calculated using only the shares available for public trading.
Example: Consider a company, EcoPower Energy, with a total of 20 million shares outstanding and a current share price of $50. However, only 12 million of these shares are available for trading (freefloat).
- Traditional market capitalization: $50 * 20 million = $1 billion
- Free-float market capitalization: $50 * 12 million = $600 million
Impact on indices:
Stock indices, such as the DAX in Germany or the S&P 500 in the US, use free-float market capitalization to determine a company's weight within the index. This approach ensures that the index more accurately represents the portion of the company that investors can trade, rather than being skewed by large holdings that are not available for public trading.
Example: Assume EcoPower Energy is a constituent of the GreenTech 100 Index. The index calculation uses free-float market capitalization to ensure that companies with a higher proportion of their shares available for public trading have a greater influence on the index movement.
Therefore, EcoPower's impact on the GreenTech 100 Index would be based on its free-float market cap of $600 million, not its total market cap of $1 billion. This reduces the influence of large shareholders and provides a more accurate representation of the market's movements and investor sentiment.
Conclusion:
The use of freefloat in calculating market capitalization and index weightings is a crucial aspect of modern financial markets. It ensures that indices reflect the true liquidity of the market and that investors have a clear understanding of a stock's volatility and trading dynamics. By focusing on the shares that are actually available for trading, investors and analysts can make more informed decisions and gain a better understanding of market trends.
Experience Skilling's award-winning platform
Try out any of Skilling’s trading platforms on the device of your choice across web, android or iOS.
FAQs
1. What is freefloat?
Freefloat refers to shares of a company available for trading by the public, excluding shares held by insiders and major shareholders.
2. Why is freefloat important?
It affects a stock's liquidity, volatility, and weighting in market indices, offering insights into the stock's true market movement potential.
3. How does freefloat affect stock indices?
Indices use freefloat to ensure that their movements reflect only the marketable portion of companies' shares, providing a more accurate market representation.
4. Can the freefloat percentage change?
Yes, the freefloat percentage can change due to actions like share buybacks, additional share issuance, or changes in the holdings of major shareholders.
