Stock market basics

What is SENSEX, How is it Calculated

WHAT IS SENSEX

Sensex is the short form of words sensitive index and is an index introduced by Bombay Stock Exchange (BSE) on January 1, 1986. It is the benchmark index of BSE.

SENSEX consists of stocks of 30 blue chip companies (large, financially sound and well-established companies) from almost all major sectors, these companies are the best representatives of their sectors. Any change in market value of these stocks will directly change the value of SENSEX. BSE updates the list of these 30 companies time to time, to select the best representative of Indian equity market.

SENSEX is maintained by Standard & Poor’s (S&P) due to this reason it is written as S&P BSE SENSEX. S&P is the global market leader in index providing services. SENSEX broadly represent the pulse of Indian equity market.

Methodology of SENSEX Calculation

SENSEX was initially calculated on the basis of ‘market capitalization weighted’ methodology but from September 1, 2003, BSE adopted ‘free float market capitalization’ method for calculating SENSEX. Free float market capitalization method is the most accepted method of index calculation all over the world, all major indexes are calculated on this methodology.

Let us understand the method of SENSEX calculation.
SENSEX was first introduced in the year 1986 but its base year was adopted to 1978-79, and its base value 100.
The total market capitalization of 30 SENSEX companies was calculated for the year 1978-79 and this market capitalization value was given a representative number of 100.

For whom, who do not know what market capitalization is?
Market capitalization is the total number of shares (also called total outstanding share) multiplied by the price of one share. Market capitalization represents the entire market value of a company.
For example, Let a company has 500,000 outstanding shares in total and price of a single share is Rs. 200 then its market capitalization will be

500,000 x 200 = 100,000,000.

So the market cap of all 30 SENSEX companies in 1978-79 was given an index number of 100. If on next day, the market capitalization of these companies will increase 15% then the value of SENSEX will also increase by 15% to 115.

Now let us consider an index consists of just one stock, and
the company has 1 Crore outstanding shares each share is of Rs. 300, then its market capitalization i.e. 300 Crore will get an index value of 100. Let, on next day its share price goes up by 50% to a price of 450, so its market capitalization will also increase by 50% to 450 Crore and the index value will also increase by 50% to 150.

Let on day 3 its price declined by 10% to Rs. 405 then index will also decrease by 10% to 135 points.

Now let we expand this example for two stocks.
Let two companies X and Y with a total number of shares 1000 and 2000 respectively, and per share price of Rs. 120 and Rs. 40 respectively.

So the market cap for these companies will be-

Market cap of X = 1000 x 120 = 120,000.
Market cap of Y = 2000 x 40 = 80,000.

That is total market cap will be 200,000 this value will get an index number of 100 on day one.

Let on day 2, the price of X increased to Rs. 180 and price of Y increased to Rs. 50 so the new market cap will be 280000, that is increased by 40% so the new index value will also increase by 40% to 140.

Let on day 3 price of X decreased to Rs. 140 and price of B remains unchanged the new market cap will be

240,000, i.e. decreased by 14.29%
So index value will also decrease by 14.29% from its 140 level that is new index value will be 120 points.

Another simpler way to perform this calculation is, we can
multiply the market capitalization at any point of time to the factor known as Index divisor.
As in our example, we can calculate index value on day 2 by multiplying market cap to index divisor.

Index on day 2:
280,000 x 100/200,000 = 140.
The factor 100/200,000 is called index divisor.

Similarly, Index on day 3:
240,000 x 100/200,000 = 120.

“Index divisor = Index value on day one / Market cap on day one.”

Free float capitalization weighted method of SENSEX calculation

Because in limited companies, there are different types of share
holders. And the majority of shares are held by
institutional investors (FIIs, MFs, hedge funds etc.), government,
and by promoters. These shares do not remain available to trade in normal cases.

While calculating the index only those shares are considered, which are available for the public to trade. The shares which are available to trade by the public are called free float shares.

For calculating free float market capitalization we have to multiply total market capitalization by free float factor. Free float factor is the percentage of shares which are available for the public to trade in normal circumstances.

Let a company has 2 crore shares and price of each share is Rs. 400 that is its total market capitalization will be 800 Crores. Let 70% of its shares are held by institutional investors, promoters, and government.
So only 30% share will be available for public to trade, that is its free float factor will be

30/100= 0.3.

So its free float market capitalization will be 800 x 0.3 = 240 Crores.

Only this free float market cap will be considered in free float
market capitalization weighted method.

BSE adopted free float market capitalization method for SENSEX calculation from 1 September 2003.

‘Free float market capitalization weighted’ method is widely accepted for index calculation for almost all major indexes all around the world.

All BSE listed companies are instructed to disclose their free float shares with the stock exchange on a quarterly basis. Anyone can access this free float market share data from BSE website.

On multiplying the free float shares by its current market price you will get free float market capitalization of SENSEX companies. Now divide this free float market capitalization with index divisor to get current index value.

Frequency of SENSEX calculation

During normal market hours, BSE performs this calculation every fraction of a second (that is every time when the price of underlying stocks change) so it displays the SENSEX value in real time.

Some historical SENSEX data

There is some historical SENSEX data you may like to know.
03/04/1979 — closing price 124.15
04/04/1979 — closing price 122.85
02/01/1986 — closing price 549.43
03/01/1986 — closing price 561.01

Before SENSEX there was not a convenient way to represent the market statistics in a broad way.
It is the oldest index of Indian stock market. One can easily analyze the bulls and bears of Indian equity market by analyzing SENSEX over a fairly long period (from 1979 onward).

SENSEX is among the most popular indexes in domestic as well as global media. Due to its broadness and popularity SENSEX is sometimes referred as the pulse of Indian equity market, it reflects the health of Indian equity market in a true sense.

 

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