This free float would include total numbers of shares minus the number of shares held by the promoters, government and shares that are locked-for a specified duration.
Guidelines from SEBI
The Securities and Exchange Board of India (SEBI) had set norms that the free float capitalization of every company listed on the stock exchange must be at least 25 per cent.
What this means is that if the total number of shares that a company has is 10,000, than at least 2500 must be free float. There were many companies where the shareholding of the promoter was very large and thus limiting the free float of the shares of the company.
This was particularly true in government owned shares of Indian companies. In order to adhere to the SEBI guidelines, many promoters sold their shares through the qualified institutional placement route.
Why is free float important?
At times if the free float is very limited, liquidity in a stock is poor. For example, no big institution like LIC or Foreign Funds will buy shares if the liquidity is poor due to the small free flat. Let's give an example: Say the total number of shares of Company A is 1,00,000. If the free float is just 10,000, than the liquidity in the scrip is very poor. Therefore, it's important that the free float remains high.
The BSE Sensex was India's first free float index and was launched in 2001. The CNX Nifty Index on the other hand has 66.85 per cent of the free float market capitalization of the stocks listed on NSE as on June 30, 2014.
The Sensex is calculated based on a free float capitalisation method, which is different from the market capitalization method.
Many stocks do not make it to the Sensex 30 and the Nifty 50 because of the low free float and liquidity in these stocks.