Sensex Demystified

Ever wonder what Sensex means and how it is calculated?
Sensex is short form for Sensitive Index. It is an indicator of the stocks in the Bombay Stock Exchange. Sensex is calculated taking stock prices of 30 different BSE listed companies.It is calculated using the “free-float market capitalization” method. This is a world wide accepted method as one of the best methods for calculating a stock market index.

Market capitalization:
It is the worth of a company in terms of its shares.If you were to buy all the shares of a particular company what is the amount you would have to pay? This amount is called the market capitalization.

Market capitalization = Current share price * number of shares issued by the company

What are ‘mid-cap’, ’small-cap’ and ‘large-cap’ stocks? The stocks are just divided into these categories depending on the value of the market capitalization of the company.

Free-float market capitalization:
A company may have certain shares in the open market and certain shares that are not available for trading in the open market. The open market shares that are free for trading by anyone, are called the ‘free-float’ shares.
According the BSE, any shares that do not fall under the following criteria, can be considered to be open market shares:

* Holdings by founders/directors/ acquirers which has control element
* Holdings by persons/ bodies with “controlling interest”
* Government holding as promoter/acquirer
* Holdings through the FDI Route
* Strategic stakes by private corporate bodies/ individuals
* Equity held by associate/group companies (cross-holdings)
* Equity held by employee welfare trusts
* Locked-in shares and shares which would not be sold in the open market in normal course.

A company has to submit a complete report about “who has how many of the company’s shares” to the BSE. On the basis of this, the BSE will decide the “free-float factor” of the company. If you multiply the “free-float factor” with the “market cap” of that company, you will get the “free-float market cap” which is the value of the shares of the company in the open market.

Free-float market capitalization = free-float factor * market capitalization

Simply, it is the total cost of buying all the shares in the open market.

Sensex Calculation:
Find out the “free-float market cap” of all the 30 companies that make up the Sensex and add them.
Let the value be X.
The base year of Sensex is 1978-79 and the base value is 100.
Simply understand that base year means the year from which they started calculating Sensex.
Lets not worry about how many companies made up sensex during 1978-79, lets assume the sum of free-float market capitalization of those companies is Y.

So for value Y the sensex value is 100, now for value X what is the sensex value?
Hope you remember ratios and proportions!
So Current value of Sensex = X * (100/Y)

Sensex is calculated every 15 seconds during market hours.

Example:

Suppose the Index consists of only 2 stocks: Stock A and Stock B.

Suppose 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.

Similarly, company B has 2,000 shares in total, of which 1,000 are held by the promoters and the rest 1,000 are free-floating.
Now suppose the current market price of stock A is Rs 120. Thus, the ‘total’ market capitalisation of company A is Rs 120,000 (1,000 x 120), but its free-float market capitalization is Rs 96,000 (800 x 120).

Similarly, suppose the current market price of stock B is Rs 200. The total market capitalization ofcompany B will thus be Rs 400,000 (2,000 x 200), but its free-float market cap is only Rs 200,000 (1,000 x 200).

So as of today the market capitalisation of the index (i.e. stocks A and B) is Rs 520,000 (Rs 120,000 + Rs 400,000); while the free-float market capitalisation of the index is Rs 296,000. (Rs 96,000 + Rs 200,000).

The year 1978-79 is considered the base year of the index with a value set to 100. What this means is that suppose at that time the market capitalisation of the stocks that comprised the index then was, say, 60,000 (remember at that time there may have been some other stocks in the index, not A and B, but that does not matter), then we assume that an index market cap of 60,000 is equal to an index-value of 100.

Thus the value of the index today is = 296,000 x 100/60,000 = 493.33

This is how the Sensex is calculated.

Which 30 companies will make up the sensex?

The following are the requirements for selecting the 30 stocks:

Market capitalization: The company should have a market capitalization in the Top 100 market capitalization’s of the BSE. Also the market capitalization of each company should be more than 0.5% of the total market capitalization of the Index.

Trading frequency: The company to be included should have been traded on each and every trading day for the last one year. Exceptions can be made for extreme reasons like share suspension etc.

Number of trades: The scrip should be among the top 150 companies listed by average number of trades per day for the last one year.

Industry representation: The companies should be leaders in their industry group.

Listed history: The companies should have a listing history of at least one year on BSE.

Track record: In the opinion of the index committee, the company should have an acceptable track record.

Courtesy: indiahowto.com