Float adjusted

What Is Float Adjusted?

"Float adjusted" refers to a methodology used primarily in financial markets to calculate the market capitalization of a company for inclusion in a stock market index. Within the broader field of Market Index Methodology, this approach accounts only for the shares of a company that are readily available for trading in public equity markets, rather than the total number of shares outstanding. By excluding shares that are not typically traded, such as those held by insiders, governments, or other strategic investors, a float-adjusted calculation aims to provide a more accurate representation of the market value that is accessible to general investors.

History and Origin

The concept of float-adjusted market capitalization gained prominence as global index providers recognized the need for benchmarks that more precisely reflected the investable opportunity set in public markets. Historically, many indices were calculated using full market capitalization, meaning all outstanding shares were counted, regardless of their tradability. However, as global markets grew and cross-border investment objectives became more sophisticated, it became apparent that a significant portion of a company's total shares might be locked up and not available for purchase by the wider investment community.

Major index constructors, such as MSCI and S&P Dow Jones Indices, began to transition their methodologies to incorporate float adjustments in the early 2000s. For instance, MSCI detailed significant free-float changes to its Standard Index Series, effective November 2001, to better reflect the market capitalization freely available to investors¹¹. Similarly, S&P Dow Jones Indices, a prominent provider of equity indices, adopted a float-adjusted approach for its market capitalization-weighted indices to enhance their investability⁹, ¹⁰. This shift was a crucial evolution in index design, moving towards a more realistic reflection of market liquidity and tradable value.

Key Takeaways

• Float adjusted refers to counting only shares available for public trading, excluding restricted shares.
• This methodology is widely used by major index providers like S&P Dow Jones Indices and MSCI for calculating index constituents.
• It aims to provide a more accurate representation of a company's investable market value and enhance index investability.
• Shares held by strategic investors, governments, or insiders are typically excluded from the float adjustment.
• A larger public float generally correlates with lower volatility for a stock.

Formula and Calculation

The calculation for float-adjusted market capitalization involves determining the number of freely tradable shares, often referred to as the public float, and then multiplying this by the current share price.

The formula can be expressed as:

Here:

• Share Price is the current market price per share of the company's stock.
• Number of Free-Float Shares represents the total shares outstanding minus shares considered "locked-in" or not readily available for trading.

Index providers often apply an "Investable Weight Factor" (IWF) to the total shares outstanding to arrive at the free-float shares. The IWF is a multiplier reflecting the proportion of shares available to the public. For example, if 77% of a company's shares are considered freely tradable after accounting for strategic holdings, the IWF would be 0.77⁸.

Interpreting the Float Adjusted Concept

Interpreting the "float adjusted" concept is crucial for understanding how major stock market indices are constructed and how they aim to represent market movements. When an index uses a float-adjusted methodology, it implies that the influence of a company within that index is based not on its entire theoretical market value, but on the portion that is actually available for purchase by investors.

This approach means that companies with a large portion of their shares held by controlling shareholders or governments will have a lower effective weight in a float-adjusted index compared to a full market capitalization index, even if their total outstanding shares are high. For example, a company with significant government ownership might have a smaller impact on a float-adjusted index's performance than its total market value would suggest. This provides a more realistic view for institutional investors and retail investors, especially those engaged in passive investing through index funds.

Hypothetical Example

Consider two hypothetical companies, Alpha Corp and Beta Inc., operating in the same industry sector.

Alpha Corp:

• Total shares outstanding: 100 million
• Current share price: $50
• Shares held by founders (strategic, non-tradable): 30 million
• Shares held by a government entity (strategic, non-tradable): 10 million

Beta Inc.:

• Total shares outstanding: 80 million
• Current share price: $60
• Shares held by insiders (non-tradable): 5 million
• Shares held by a long-term private equity firm (strategic, non-tradable): 3 million

To calculate their float-adjusted market capitalization:

Alpha Corp:

• Free-float shares = 100 million (total) - 30 million (founders) - 10 million (government) = 60 million shares
• Float-adjusted market capitalization = 60 million shares $\times$ $50/share = $3 billion

Beta Inc.:

• Free-float shares = 80 million (total) - 5 million (insiders) - 3 million (private equity) = 72 million shares
• Float-adjusted market capitalization = 72 million shares $\times$ $60/share = $4.32 billion

In this scenario, even though Alpha Corp has more total shares outstanding, Beta Inc. has a higher float-adjusted market capitalization due to a larger proportion of its shares being freely tradable. This distinction is critical for proper portfolio construction and for ensuring that an index accurately reflects the investable market.

Practical Applications

The "float adjusted" methodology is a cornerstone of modern stock market index construction, with several practical applications across finance:

• Index Calculation: Major index providers, including S&P Dow Jones Indices and MSCI, widely use float adjustment to determine the weight of individual companies within their benchmarks⁷. This ensures that the indices primarily reflect the market value available to public investors. As a Reuters explainer highlights, indices are typically weighted by float-adjusted market capitalization⁶.
• Exchange-Traded Funds (ETFs): Most exchange-traded funds that track market capitalization-weighted indices rely on float-adjusted data. This ensures that the ETF's holdings correspond to the investable portion of the market, which is vital for effective diversification and tracking accuracy.
• Market Representativeness: By excluding illiquid or strategically held shares, float adjustment provides a more accurate picture of the real market size and the collective value of publicly traded companies. This is particularly important in emerging markets where state or family ownership can be substantial.
• Liquidity Assessment: The number of free-floating shares is inversely correlated with a stock's volatility; generally, a larger public float suggests higher liquidity and potentially lower price swings. This information is valuable for traders and portfolio managers assessing entry and exit points.
• Corporate Actions: The float-adjusted share count is continuously monitored and updated by index providers to reflect corporate actions such as initial public offerings (IPOs), share buybacks, and secondary offerings, which can alter the number of freely tradable shares⁴, ⁵.

Limitations and Criticisms

While float adjustment offers significant advantages in providing a more realistic view of the investable market, it also has limitations and has faced some criticisms:

• Subjectivity in Definition: The definition of "non-free float" shares can sometimes involve a degree of subjectivity. Different index providers may have slightly varying criteria for what constitutes a strategic holding or a locked-in share, which can lead to minor discrepancies in a company's float-adjusted market capitalization across different indices.
• Data Collection Challenges: Accurately identifying and tracking all non-free float shares, especially in less transparent markets, can be challenging. Index providers rely on various public sources and disclosures, but complete information may not always be readily available³.
• Impact on Index Rebalancing: Changes in a company's float, perhaps due to insider sales or strategic divestments, can trigger rebalancing events within an index. While these adjustments aim to maintain accuracy, frequent or significant changes can lead to higher transaction costs for index funds and ETFs that track these benchmarks.
• Exclusion of Long-Term Holders: While the goal is to exclude shares not available for trading, some long-term holders, such as certain institutional investors with passive strategies, might be mistakenly categorized as part of the "non-free float" if their holdings are large and appear less active, even if they theoretically could trade those shares. This can slightly understate the true tradable portion.

Float Adjusted vs. Full Market Capitalization

The key difference between "float adjusted" and "full market capitalization" lies in the count of shares used to determine a company's market value, particularly for stock market index weighting.

Confusion often arises because both methods involve "market capitalization." However, the float-adjusted method refines this by considering the practical availability of shares, providing a more relevant metric for investment benchmarks and portfolio construction.

FAQs

Why is float adjusted important for stock market indices?

Float adjusted is important for stock market indices because it ensures that the index reflects the shares truly available for public trading. This makes the index more representative of the actual market that investors can access and helps improve its investability.

What types of shares are typically excluded from a float-adjusted calculation?

Shares typically excluded from a float-adjusted calculation include those held by company insiders (such as executives and board members), governments, strategic corporate investors, and shares subject to lock-up agreements (e.g., post-IPO shares). These are considered "non-free float" shares as they are not readily available for sale in the open market².

Do all stock market indices use the float-adjusted method?

No, not all stock market indices use the float-adjusted method. While it has become the prevailing standard for many major market capitalization-weighted indices, some older or specialized indices might still use a full market capitalization method or other weighting schemes, such as price-weighted or equal-weighted methods¹.

How does float adjustment affect the weight of a company in an index?

Float adjustment can significantly affect a company's weight in an index. If a company has a large percentage of its shares outstanding held by non-public investors, its float-adjusted market capitalization will be lower than its full market capitalization. Consequently, its weight within a float-adjusted index will be proportionally smaller, reflecting the limited supply of its shares available for trade.