On 26th May 2017, the SENSEX breached the 31,000 level for the first time. This post explains what Sensex means and how it is calculated in details.
What is SENSEX?
The Sensex is primarily an index reflecting the movement of the share prices in the Bombay Stock Exchange (BSE). If the Sensex value goes up, it means there is a general increase in prices of shares and vice versa.
One can identify the booms and busts in the Indian stock market through S&P BSE SENSEX. The other index calculated in India is Nifty for the National Stock Exchange. (NSE)
Sensex was first compiled in 1986.
The BSE and S&P Dow Jones Indices have entered into an alliance to calculate SENSEX from Feb 19, 2013
What is the methodology used to calculate Sensex?
Initially, Sensex used the weighted market capitalisation methodology.
It shifted to ‘Free Float market capitalization‘ methodology with effect from September 1, 2003. All major indices around the world use the free-float methodology.
What is meant by free float?
Free-float is that percentage of total shares issued by the company that are readily available for trading in the market. It excludes shares held by promoters, government etc.
To illustrate: If a company has 100 shares in total, of which 39 are held by the promoters, Government etc and 61 shares are available for trading to the general public. These 61 shares are the ‘free-floating’ shares and the free float percentage will be 61 % or 0.61.
What is meant by market capitalisation?
Market capitalisation represents the valuation of a company. It is determined by multiplying the price of their stocks with the number of shares issued by that company. Market capitalisation = price * quantity
Free-float market capitalisation is determined by multiplying the total market capitalisation with the free float factor.
BSE determines the free-float factor based on the percentage of free float. The free float percentage is rounded off to a higher multiple of 5.
To continue with the above illustration, the free float percentage is 61 % or 0.61. Hence, the free float factor is 0.65
So, free-float market capitalisation = market capitalisation * free float factor
Explain the steps in the calculation of SENSEX.
- The Sensex comprise of a basket of 30 stocks. First, the 30 companies are selected on the basis of various quantitative and qualitative criteria like total market capitalisation, free float market capitalisation, sectoral representation etc. Basically, there should be companies from all major sectors like Banking, IT, FMCG.
- The market capitalisation of each of the 30 companies is determined.
- The free-float market capitalisation of each of the 30 companies is determined. The market capitalization is multiplied by the free-float factor to arrive at the free-float market capitalization.
- The free-float market capitalisation of the 30 companies is summed up. We get the total free-float market capitalisation.
- The formulae used to calculate Sensex: Sensex = (total free-float market capitalisation/ Base market capitalisation) * Base index value.
- We have calculated the total free-float market capitalisation. The base year to calculate Sensex is 1978-79.
- So, base market capitalisation is calculated. It means the market capitalisation in 1978-79. The base is a static value, but it has to be changed to account for bonus and rights issues etc. As per the BSE website, the figure of Rs. 2501.24 crore will be used as the base market capitalisation till the next adjustments become necessary.
- The base index value is 100
Hence, to calculate Sensex, we will add the free-float market capitalisation of 30 selected companies, divide the resultant figure by 2501.24 crores and multiply it by 100.
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