Don’t Get Trapped by Market Cap: Why Free Float Matters More for Investors
You might not be making compulsive decisions while investing in the stock market. The right way is to research the company before buying its stocks or shares. For the same rationale, investors indulge in technical and fundamental analysis. Investors consider a wide range of metrics like the P/E ratio, annual turnover, and dividend yield to learn more about a government or corporate entity. One of the powerful metrics used by investors to know more about a company is market capitalisation. Even though the market cap is an essential metric, it is not everything. To understand a company’s worth and liquidity, you must be familiar with the free float market cap. Read on to understand why free float matters more for investors.
The market capitalisation metric
Before discussing the power of free-float, let us discuss the importance of market capitalisation. It is a crucial metric that gives an idea of a company’s total worth in the stock market. Market capitalisation can be evaluated for both private and public companies. However, most investors use the metric, especially to evaluate the worth of public companies in the stock market. It happens because the share information of private companies is not available to the common public. For the same rationale, knowing the market capitalisation of a private company is a challenge. Since investors can understand the company’s worth by knowing the market cap, they make informed decisions.
Investors must know how to calculate the market cap for a company to make informed decisions. To calculate the market cap, you must first determine the number of outstanding shares for a company. Outstanding shares are the issued ones that are held by investors currently. These investors can be institutional, strategic, or individual. Shares held by insiders in a company are also referred to as outstanding shares. When the number of outstanding shares is known, multiply it by the company’s current share price. For instance, assume that a company has 50,000 outstanding shares and the current share price in the stock market is INR 25. In such a case, the market cap will be 50,000 * 25 = INR 12,50,000.
Are you familiar with the free-float market cap metric?
As discussed above, the market gives an idea of the company’s worth in the share market. However, it does not give a clear picture of liquidity and price stability. It happens because the market cap considers all outstanding shares, including the ones held by insiders and strategic investors. To have a clear picture of the company’s liquidity and price stability, investors must consider calculating the Free Float Market Cap. To calculate the free float cap, the first step is to remove the shares held by insiders and strategic investors. Since these shares cannot be sold easily due to restrictions, they aren’t considered for the calculation of the free-float cap. All shares held by investors having no selling restrictions are considered for the free-float cap. These shares are also called free-floating shares by investors.
Once you have the number of free-floating shares, multiply it by the current share price to obtain the free float market cap. For instance, assume that the number of free-floating shares of a company is 50,000 and the current share price is INR 200. In such a case, the free-float cap will be 50,000 * 200 = INR 1,00,00,000. Here’s why the free-float cap matters more for investors:
- Free-float cap gives an idea of the free-tradable shares of a company. When a company has more freely-tradable shares, it denotes high liquidity.
- When there are fewer free-floating shares, prices might change drastically. For price stability, you must choose companies with more free-floating shares.
- When free-floating shares are more for a company, it represents the governing power with the public. Companies with fewer free-floating shares have their governing authority distributed more among the insiders.
- Free-float cap gives a better picture of a company’s worth in the stock market than market capitalisation.
In a nutshell
Market cap isn’t the only stop for investors to learn more about a company worth. Free float market cap is more powerful than market cap, as it helps understand the liquidity and price stability of a company’s shares. Start using the free-float cap to make investment decisions!