What is Free Float Market Capitalization? - Method & Examples

Instructor: James Walsh

M.B.A. Veteran Business and Economics teacher at a number of community colleges and in the for profit sector.

This lesson will explain the difference between free float market capitalization and the traditional full market capitalization. A simple example will take you through the calculations for both of these and their impacts on stock indexes.

Stock Indexes

Mark manages the Backyard Average, a stock index that measures the performance of companies located in his home city. A stock index is a way of measuring the performance of a group of stocks as a single number. We hear important stock indexes mentioned often in the news. When an index goes up, it means that the weighted average price of the stocks in the index went up. Mark's index is widely followed by local investors because it is a reliable sign of how well the local economy and its businesses are doing. Mark knows that investors will always follow the major indexes and averages that they hear about in the news, but he knows they are also interested in the health of the companies located in their own backyard.

Weighting a Stock Index by Market Capitalization

Mark's index tracks 25 companies that he knows are not all created equally. He wants the stock price movements of the larger companies to have a greater impact on his index number than the price movements of smaller companies. He decides that the best way to accomplish this is to weight each company in the index according to its size. Investors measure a company's size by its market capitalization or market cap. Market capitalization equals a company's share price times the number of shares it has outstanding. Market cap is the value that the investment community places on a company. Here is a simple example of a three-stock index weighted by market capitalization.

Weighting by full market cap
Market Cap

Company A has the greatest market cap of the three. The weighting is calculated by dividing the market cap of a company in the index by the total market cap for the index. In this example, the weighting for Company A is 100 Million / 180 Million = 55%. That means Company A is 55% of the index. Price movements in the stock of Company A will have a greater influence on the index number than price movements in small Company C.

Free Float Methodology

Mark has been wondering if weighting the stocks in this index by pure size is the best way to measure market movements and price changes in the stocks. Some of his followers have suggested he use free float market capitalization instead of total market capitalization. The free float method measures the number of shares actually available in the market for the public to buy and sell rather than using all of the outstanding shares, like the full market capitalization method does.

There are many reasons why shares that are issued and outstanding are not available to the public. There are some large and well-known companies where the founding family holds a large number of shares. These will likely never be sold and never be available. Many companies also have ESOP'S or employee stock ownership plans, whereby shares will typically not be sold as long as the employee stays with the company. Governments and company insiders, such as top management can also own shares that will not be sold in the near future. Securities exchanges also have regulations that don't allow issued shares to be sold right away. Free float methodology adjusts the total number of outstanding shares by subtracting these shares that are unavailable from the total.

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