BSE SENSEX

The Sensex has a very important function. The Sensex is supposed to be an indicator of the stocks in the BSE. It is supposed to show whether the stocks are generally going up, or generally going down.

To show this accurately, the Sensex is calculated taking into consideration 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.

Please note: The method used for calculating the Sensex and the 30 companies that are taken into consideration are changed from time to time. This is done to make the Sensex an accurate index and so that it represents the BSE stocks properly.


Market capitalization-
You probably think that you have never heard of the term “market capitalization” before. You have! When you are talking about “mid-cap”, “small-cap” and “large-cap” stocks, you are talking about market capitalization!

Market cap or market capitalization is simply the worth of a company in terms of it’s shares! To put it in a simple way, if you were to buy all the shares of a particular company, what is the amount you would have to pay? That amount is called the “market capitalization”!

Many different types of investors hold the shares of a company! The Govt. may hold some of the shares. Some of the shares may be held by the “founders” or “directors” of the company. Some of the shares may be held by the FDI’s etc. etc!

Now, only the “open market” shares that are free for trading by anyone, are called the “free-float” shares. When we are calculating the Sensex, we are interested in these “free-float” shares!

A particular company, may have certain shares in the open market and certain shares that are not available for trading in the open market.

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. The “free-float factor” is a very valuable number! 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!
A simple way to understand the “free-float market cap” would be, the total cost of buying all the shares in the open market!

So, having understood what the “free float market cap” is, now what? How do you find out the value of the Sensex at a particular point? Well, it’s pretty simple….
First: Find out the “free-float market cap” of all the 30 companies that make up the Sensex!

Second: Add all the “free-float market cap’s” of all the 30 companies!

Third: Make all this relative to the Sensex base. The value you get is the Sensex value!

The “third” step probably confused you. To understand it, you will need to understand “ratios and proportions” from 5th standard mathematics. Think of it this way:

Suppose, for a “free-float market cap” of Rs.100,000 Cr... the Sensex value is 4000…
Then, for a “free-float market cap” of Rs.150,000 Cr... the Sensex value will be..

So, the Sensex value will be 6000 if the “free-float market cap” comes to Rs.150,000 Cr!

Please Note: Every time one of the 30 companies has a “stock split” or a "bonus" etc. appropriate changes are made in the “market cap” calculations.

Now, there is only one question left to be answered, which 30 companies, why those 30 companies, why no other companies?

The 30 companies that make up the Sensex are selected and reviewed from time to time by an “index committee”. This “index committee” is made up of academicians, mutual fund managers, finance journalists, independent governing board members and other participants in the financial markets.

The main criteria for selecting the 30 stocks is :
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.
Having understood all this, you now know how the Sensex is calculated.