It is said that if you are looking for high returns from your investments, then you should consider the stock market. But investing in the stock market comes with some risks- between 2008 and 2011 the Sensex fluctuated between 7700 points to 21,200 points! So, it is advisable to have a complete understanding of the stock market before making an investment.
Keeping this in mind, let’s build our knowledge from the very basic- by understanding what Sensex is and how its value is calculated.
The Birth of Sensex
Sensex (Sensitive Index) is the index of the Bombay Stock Exchange (BSE).
Bombay Stock Exchange, which was started in 1875, did not have a scale to measure the ups and downs in the stock market. It was only on 1st Jan 1986 that BSE came out with a stock index-the Sensex- that subsequently became the barometer of the Indian stock market.
Sensex consists of the 30 largest and most actively traded stocks, representative of various sectors, on the Bombay Stock Exchange. As the oldest index in the country, it provides the time series data over a fairly long period of time and judicially captures the booms and busts of the Indian stock market.
How Is Sensex Calculated?
The Sensex was initially calculated based on the “Full Market Capitalization” methodology but was shifted to the “Free-float methodology” with effect from September 1, 2003.
As per the Free-float Market Capitalization methodology, the level of index at any point of time reflects the Free-float market value of 30 component stocks relative to a base period. All major index providers like MSCI, FTSE, STOXX, S&P and Dow Jones use the Free-float methodology.
Suppose a company A has 1,000 shares in total, of which 200 are held by the promoters, so that only 800 shares are available for trading to the general public. These 800 shares are the so-called ‘free-floating’ shares. If the price of each share is Rs. 120/-, then the ‘total’ market capitalization of the company is Rs 120,000 (1,000 x 120), but its free-float market capitalization is Rs 96,000 (800 x 120).
The calculation of Sensex involves the following steps broadly:
Calculate the market capitalization of each of the 30 companies in the index by multiplying their stock price by the number of shares issued by that company.
Multiply the market capitalization by the free-float factor to determine the free-float market capitalization.
Free-float factor of a company is a multiple with which the total market capitalization of that company is adjusted to arrive at its Free-float market capitalization. It is determined by BSE based on the information submitted by the companies. The value of Free-float factor lies between 0.05 and 1.00. A Free-float factor of say 0.55 means that only 55% of the market capitalization of the company will be considered for index calculation.
Divide the free-float market capitalization of the Index constituents by a number called the Index Divisor. The Divisor is the only link to the original base period value of the Sensex. It keeps the Index comparable over time and is the adjustment point for all Index adjustments arising out of corporate actions.
Suppose the Index consists of only 2 stocks: Stock X and Stock Y. Then, the table below shows the SENSEX calculation:
Understanding the result:
Step 1 and Step 2 are self-explanatory. Let’s understand the Step 3.
The year 1978-79 is considered the base year of the index with a value set to 100. What this means is that if at that time the market capitalization of the stocks that comprised the index was 60,000, then the index-value at that time would be 100. So, using simple unitary method, we can find the corresponding present value of the SENSEX.
The factor 100/60000 is called the index divisor.
What are the 30-benchmark stocks?
The 30-benchmark stocks are given below, along with their Free-float factor:
Note that this list keeps on changing from time to time, based on the various guidelines that BSE follows for the selection of benchmark stocks.
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