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 readily available in the market.Rather than using all of the shares (both active and inactive shares), as is the case with the full-market capitalization method, the free-float method excludes locked-in shares, such as those held by insiders, promoters, and governments.
Free-Float Market Capitalization Method
Definition
The free-float market capitalization method is a way to calculate the market capitalization of companies in a stock market index. It involves multiplying the stock price by the number of shares available for trading in the market. Unlike the full market capitalization method, which includes all shares (active and inactive), the free-float method excludes locked-in shares, such as those held by insiders, promoters, and the government.
Origin
The concept of the free-float market capitalization method originated in the late 20th century. As stock markets globalized and investors demanded greater transparency, this method became widely adopted. Key events include the late 1990s and early 2000s when major stock indices like the S&P 500 began using the free-float method.
Categories and Characteristics
The free-float market capitalization method can be divided into two main categories: full free-float and partial free-float. The full free-float method considers only shares that are completely available for trading, while the partial free-float method may include some restricted but still tradable shares. Its characteristics include:
- More accurately reflecting market liquidity
- Excluding the impact of inactive shares
- Increasing market transparency
Specific Cases
Case 1: The S&P 500 Index adopted the free-float market capitalization method in 2005, excluding shares held by insiders and the government, making the index more reflective of actual market liquidity.
Case 2: The Hang Seng Index in Hong Kong also began using the free-float method in 2006, enhancing the index's representativeness and transparency.
Common Questions
1. Why use the free-float market capitalization method?
The free-float method more accurately reflects actual market liquidity by excluding inactive shares.
2. What are the drawbacks of the free-float method?
It may overlook some potentially valuable but temporarily inactive shares.
