In the previous article of this series, we have learned about the Market Index, Stock Market, NSE and BSE.
Now that we have the basic idea, let us understand how Sensex and Nifty work !!
METHOD ADOPTED FOR SENSEX CALCULATION –
The method adopted for calculating Sensex is the market capitalisation weighted method in which weights are assigned according to the size of the company. Larger the size, higher the weightage.
The base year of Sensex is 1978-79 and the base index value is set to 100 for that period.
WHY IS THE BASE VALUE SET TO 100 POINTS?
The total value of shares in the market at the time of index construction is assumed to be ’100′ in terms of ‘points’. This is for the purpose of ease of calculation and to logically represent the change in terms of percentage. (So, next day, if the market capitalization moves up 10%, the index also moves 10% to 110.)
HOW ARE THE STOCKS SELECTED?
The stocks are selected based on a lot of qualitative and quantitative criteria, as well as the financial soundness and performance.
HOW IS THE INDEX CONSTRUCTED?
The construction technique of index is quite easy to understand if we assume that there is only one stock in the market.
In that case, the base value is set to 100 and let’s assume that the stock is currently trading at 200. Tomorrow the price hits 260 (30% increase in price) so, the index will move from 100 to 130 to indicate that 30% growth.
Now let’s assume that on day 3, the stock finishes at 208. That’s a 20% fall from 260. So, to indicate that fall, the Sensex will be corrected from 130 to 104(20%fall).
As our second step to understand the index calculation, let us try to extend the same logic to two stocks – A and B.
A is trading at 200 and let’s assume that the second stock ‘B’ is trading at 150. Since the Sensex follows the market capitalization weighted method, we have to find the market capitalization (or size of the company- in terms of price) of the two companies and proportionate weightage will have to be given in the calculation.
How do we compute the size of the company- in terms of price?
That’s simple. Just multiply the total number of shares of the company by the market price. This figure is technically called ‘market capitalization’.
Back to our example –
We assume that company A has 100,000 shares outstanding and B has 200,000 shares outstanding. Hence, the total market capitalization is (200 x 100000 + 150 x 200000) = Rs 500 lakhs. This will be equivalent to 100 points.
Let’s assume that tomorrow, the price of A hits 260 (30% increase in price) and the price of B hit 135. (10% drop in price).
The market capitalization will have to be reworked. It would be –  (260 x 100,000 + 135 x 200,000) = 530 lakhs.
That means, due to the changes in price, the market capitalization has moved from 500 lakhs to 530 indicating a 6% increase. Hence, the index would move from 100 to 106 to indicate the net effect.
This logic is extended to many selected stocks and this calculation process is done every minute and that’s how the index moves!
CALCULATION OF SENSEX –
What we said was the general method to construct indices. Since the Sensex consists of 30 large companies and since their shares may be held by the government or promoters etc., for the purpose of calculating market capitalization only the free float market value is considered, instead of the total number of shares.
What is free float?
That’s the total number of shares available for the public to trade in the market. It excludes shares held by promoters, governments or trusts, FDIs etc.
To find the free float market value, the total value of the company (total shares x market price) is further multiplied by a free float market value factor, which is nothing but the percentage of free float shares of a particular company.
So logically, the company which has more public holding will have the highest free float factor in the Sensex. This equalizes everything.
Example- Let’s assume that the market value of a company is Rs 100,000 Crore and it has 100 Crore shares having a value of Rs 1,000 each but only 20% of it are available to the public for trade. The free float factor would be 20/100 or 0.20 and the free float market value would be .20 x 100,000 = 20,000 Crores.
You need not calculate the free float market capitalization since its available straight on the BSE website.
NOW, LET’S SE HOW THE SENSEX MOVES.
Sensex value = Current free– Float market value of constituents stocks/Index Divisor
So, the numerator is available straight from the BSE site. It’s the total of free float factors of 30 stocks x market capitalization.
Now, THE DENOMINATOR – Index Divisor
The Index divisor nothing but the present level of the index.
So, now, we have all the figures.
Let us assume that the free-float market capitalisation is Rs 10,00,000 Crore. At that point, the Sensex is at 12500. What would be the value of Sensex if the free-float market capitalization is Rs 11,50,000 Crore?
(Those who can’t find the answer may go back to the ratios and proportions chapter )
The answer is 14,375. (12,500/10,00,000 X 11,50,000)
CALCULATION OF NIFTY –
Nifty is calculated using the same methodology adopted by the BSE in calculating the Sensex – but with three differences. They are:
- The base year is taken as 1995.
- The base value is set to 1000.
- Nifty is calculated on 50 stocks actively traded in the NSE.
50 top stocks are selected from 24 sectors.
The selection criteria for the 50 stocks are also similar to the methodology adopted by the Bombay stock exchange.
Here is the mathematical formula to arrive at the value of NIFTY –
Market Capitalization = Equity Capital x Price
Free Float Market Capitalization = Equity Capital x Price x IWF
Index Value = Current Market Value / Base Market Capital x Base Index Value (1000)
*IWF = Investible Weight Factor – It is a factor to determine the number of shares available for trading.
The index is calculated in real-time daily whenever the value of any share changes.
Difference Between Sensex and Nifty
As such, there is no difference between Sensex and Nifty since both target large-cap stocks. There’s no difference in the performance – you can see that in 20 years chart.
NIFTY and Sensex are stock market indices that indicate the strength of the market. The NIFTY reflects the value of NSE and Sensex is the stock market index for BSE.
