Free Float Market Capitalization Weighted Methodology: Changes at NSE

NSE or National Stock Exchange of India, is all set to throw a bomb-shell by changing its valuation and index computation methodology, which will see big changes in index weightage for many many companies.
The NSE is currently valuing all the indices using a full market cap basis. However, come June 26th 2009 and it will change to free float market capitalization methodology.

What is full market capitalization weighted methodology?
As I've explained in this article about Index Funds, the index like NIFTY or BSE SENSEX is calculated for top 50 and top 30 stock respectively. When we talk about taking into consideration the Market Capitalization, we talk about taking all the shares that the company has. That includes shares which are still held by the promoters, by the government and everyone.

What is Free Float Market Capitalization Weighted Methodology?
Free float market capitalization weighted methodology takes into consideration ONLY those shares which are available for public trading. So that will NOT include shares held by the promoters, the government, etc. What this will mean is that certain companies, which have high holding by the promoters will loose out on the market cap valuations.

Can we have an example explaining Free Float Market Capitalization weighted methodology?
Yes. Say, for e.g. there are a total of 10 million shares of WIPRO. Out of this, The Chairman Azim premji may be holding 85% of the shares. That will mean he is having 8.5 million shares with himself. And that leaves only 1.5 million shares to be available for free traiding.
Suppose Wipro stock price is 500 Rs. per share. So if we go by the conventional method of Full market capitalization weighted methodology, the market cap of Wipro will be calculated as follows:
Market Cap = no. of shares * share price = 10 million shares * 500 Rs. = 5000 million Rs.

However, if we go by the Free float market capitalization weighted methodology, then the market cap of Wipro will cahnge significantly. That will take into consideration only those shares which are freely available for trading to investors (1.5 million only). Hence, market capitalization of Wipro will come to = No. of free float shares * price per share = 1.5 million * 500 Rs. = 750 million Rs. Only.

Now you can see that the market capitalization of Wipro has gone down considerably, to only 15 percent of the value calculated by the Full market capitalization weighted methodology. (Please note this is only an example, actual valuation of Wipro may be quite different)

Which companies will be affected by the change to Free float market capitalization weighted methodology?
Primarily, all the companies who have high holdings by the promoters will be affected. Some may even be in the danger of being kicked out of the index as the index calculation takes in to consideration only the top 50 or top 30 companies as per the market capitalization.
So, the companies like PSU in which government is the promoter and has majority stake with the government may be hit.

What is the pattern or which index are being currently calculated as Free float market capitalization weighted methodology?
As per CNBC, the following indices maintained by IISL are already being computed using free float market capitalization methodology:
a) CNX Realty Index
b) CNX PSU Bank Index
c) S&P CNX Nifty Shariah Index
d) S&P CNX 500 Shariah Index

The CNX Nifty Junior Index will be calculated using free float market capitalization methodology with effect from May 4, 2009.
The following categories would also be excluded from the free float factor where identifiable separately:

-Government holding in the capacity of strategic investor
-Shares held by promoters through ADR/GDRs.
-Strategic stakes by corporate bodies
-Investments under FDI category
-Equity held by associate/group companies (cross-holdings)