Market capitalisation and free float

Two numbers are routinely used to describe the size of a listed company, and they answer different questions. Market capitalisation asks what the whole company is worth at the current price. Free float asks how much of it is actually available to trade. A company can score very high on the first and very low on the second, and when that happens almost everything about how its shares behave is explained by the second rather than the first.

Market capitalisation, and what it is not 

Market capitalisation is the current share price multiplied by the number of shares in issue. That is the whole calculation, and its simplicity is the source of both its usefulness and its most common misreading. The price used is the price at which the most recent share changed hands, which may have been a very small quantity. Multiplying that price by every share in existence produces a figure that assumes the same price would hold for all of them at once, which it would not.

Capitalisation is also not the value of the business. It values the equity, and a company financed with a great deal of debt has a far larger enterprise than its equity suggests, while a company holding a large cash balance has a smaller one. Two companies with identical capitalisations can therefore represent quite different amounts of underlying business. This is why capitalisation is a size measure rather than a valuation measure, and why it is a poor basis for comparing companies with different capital structures.

Companies are grouped into large, mid and small capitalisation bands, and the thresholds separating them are set by each index provider and revised over time rather than fixed by any authority. The bands are a convention for sorting, not a property of the company, and the same company can sit in different bands under different providers on the same day.

Free float, and what shrinks it 

Free float is the portion of the shares in issue that is genuinely available to the market. It is calculated by taking the total shares in issue and removing the holdings that are not expected to trade. Those exclusions typically cover government and sovereign fund stakes, founding family and foundation holdings, strategic stakes held by other listed companies, shares held by directors and insiders, shares subject to a lock up after a flotation, and treasury shares the company has repurchased and holds itself.

The distinction is easiest to see in the largest state linked and family controlled listings. Saudi Aramco is among the largest companies in the world by capitalisation while only a modest portion of its shares was ever sold to the public. Several of the largest Gulf listings, including Emaar Properties, ADNOC Gas and Aldar Properties, carry substantial strategic or state ownership. Nestlé SA carries long standing institutional and foundation holdings. Tencent Holdings and Alibaba Group carry large strategic corporate stakes. In every case the tradable market is a fraction of the headline size.

Why index providers weight on float 

A benchmark index exists partly so that funds can replicate it, and a fund can only buy shares that are for sale. An index weighted on total capitalisation would instruct every tracking fund to buy a proportion of a company that is not available, and the funds would compete for a float too small to supply them. Float adjustment removes that problem at the source: the weight is set on what can actually be bought, so the index is replicable by construction.

The consequence is that index weight and headline size come apart. A company can be among the largest in a market and carry a modest index weight, and a smaller company with a full float can carry a weight out of proportion to its business. It also means a change in float, and not only a change in price, changes the weight. A government selling down a stake, a lock up expiring after a flotation, a large secondary offering or a company cancelling treasury shares all move the float, and every tracking fund adjusts its holding to match on the effective date, which produces mechanical buying or selling that has nothing to do with the company's prospects.

What a small float does to a price 

Float is the supply side of the order book. A small float means fewer resting orders at each price level, so the same size of incoming order consumes more levels and moves the price further. That shows up as a wider spread, thinner depth behind the top of the book, larger single prints, more frequent gaps between one session and the next, and a price series that is choppier at every timescale.

It also concentrates the effect of any flow. When a small float company enters a widely tracked index, the tracking funds must collectively buy a substantial proportion of everything available, and the demand arrives on one date. The reverse happens on exclusion. These are supply events, and an order book prices imbalance regardless of what caused it, which is why index inclusion and exclusion dates are among the most reliably eventful days in a small float share's calendar.

When the share count itself changes 

Both measures rest on a share count that moves. A share split multiplies the count and divides the price by the same factor, leaving capitalisation unchanged; a consolidation does the reverse. A repurchase programme buys shares back and reduces the count, which reduces capitalisation at an unchanged price and, where the shares are cancelled, reduces the float. A new issue of shares raises the count and dilutes each existing share's claim. A rights issue does the same on terms offered to existing holders first.

For a contract written on the share rather than the share itself, the split and consolidation cases are handled by restating the contract so that exposure is unchanged, under the broker's published corporate actions policy. The float driven index events are not adjustments at all: they are ordinary price moves in the underlying, driven by supply, and they reach the contract exactly as any other price move does.