The National Stock Exchange announced that it will go the free-float way for calculating market capitalization from June 26, 2009. So what does this move from full market capitalisation method entail? A Change in methodology will mean a change in the market capitalisation (market cap) of a company as the free float method takes into account only the shares that are available for trading. Besides, this method has quite a following in the international arena too — all the major index providers such as MSCI, Nasdaq, FTSE, Dow Jones, S & P and even India’s BSE’s Sensex use the free float method — as it is considered to be a more transparent system of arriving at market cap.
Getting back to basics
The ownership of any listed company is spread across different categories. Promoters, directors, institutional investors such as banks, mutual funds and foreign investors and retail investors, make-up the shareholding pie of companies and is different for different companies. However, the problem over deciding the correct market capitalisation can occur when the promoter or institutional holding is significantly high compared to retail investors’ holding in any particular company. Full float market cap takes into account the entire shareholding; it may not be representative of the chunk of shares actually available for trading because it does not distinguish between promoters, foreign investors and retail investors.
It is this anomaly that the free float method seeks to remove, as it will exclude the shares held by promoters, institutional investors and other locked-in shares such as employee stock options.
Analysis
Take the case of ONGC where the Government holds over 70 per cent of the total outstanding shares. The stock’s current weight in the bellwether index- the Nifty is 8.6 per cent. But if one were to ascertain the stock’s market cap based on the free-float shares, its weight in the index would reduce by 3.5 percentage points to 5.1 per cent. Several other companies that sport high non-public holding, such as NTPC, Bharti Airtel, TCS and DLF would lose their index weights upon adoption of the new method. Some companies though will see their weights increasing as promoter holding is low and free float is high. ITC, Infosys, ICICI Bank, HDFC and L&T, are examples.
Advantages
The free-float method clearly reflects the market movements. Further, following this method of index calculation also shields the index from any undue influence as is the case with some closely-held large-cap stocks. What’s more, the free float method also improves the index flexibility in terms of a better spread of market and sector coverage. It may also aid index funds (that track the S&P CNX Nifty), as a free-float index may also help reduce their impact cost and tracking errors.
Getting back to basics
The ownership of any listed company is spread across different categories. Promoters, directors, institutional investors such as banks, mutual funds and foreign investors and retail investors, make-up the shareholding pie of companies and is different for different companies. However, the problem over deciding the correct market capitalisation can occur when the promoter or institutional holding is significantly high compared to retail investors’ holding in any particular company. Full float market cap takes into account the entire shareholding; it may not be representative of the chunk of shares actually available for trading because it does not distinguish between promoters, foreign investors and retail investors.
It is this anomaly that the free float method seeks to remove, as it will exclude the shares held by promoters, institutional investors and other locked-in shares such as employee stock options.
Analysis
Take the case of ONGC where the Government holds over 70 per cent of the total outstanding shares. The stock’s current weight in the bellwether index- the Nifty is 8.6 per cent. But if one were to ascertain the stock’s market cap based on the free-float shares, its weight in the index would reduce by 3.5 percentage points to 5.1 per cent. Several other companies that sport high non-public holding, such as NTPC, Bharti Airtel, TCS and DLF would lose their index weights upon adoption of the new method. Some companies though will see their weights increasing as promoter holding is low and free float is high. ITC, Infosys, ICICI Bank, HDFC and L&T, are examples.
Advantages
The free-float method clearly reflects the market movements. Further, following this method of index calculation also shields the index from any undue influence as is the case with some closely-held large-cap stocks. What’s more, the free float method also improves the index flexibility in terms of a better spread of market and sector coverage. It may also aid index funds (that track the S&P CNX Nifty), as a free-float index may also help reduce their impact cost and tracking errors.
Following are the salient features w.r.t free float market capitalization:
- In market capitalization weighted method, the level of the index reflects the total market value of all the stocks in the index relative to a particular base period.
- In free float weighted market capitalization level of an index reflects the total float-adjusted market value of all of the component stocks relative to a particular base period.
- The free float factor (Investible Weight Factor – IWF) for each company in the index will be determined based on the public shareholding of the companies as disclosed in the shareholding pattern submitted to the stock exchanges by these companies.
Because of this, on 27th june one may see few changes in market trading in Nifty.
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