The Hindu Business Line : Making sense of Sensex moves

Sensational headlines such as “Sensex in free fall”, “Bloodbath on D-Street” and “Market faces mayhem” would have surely stirred up a storm in your teacup as you read the morning newspaper in recent weeks.

But should you worry that with the Sensex down in the dumps, your equity investments too will take a similar hit? Not always.

Sensex: Just an indicator

The Sensex is an index that is composed of only 30 stocks. This means that the level of index at any point of time (say 14,152 points as on August 17) reflects the market value of its component stocks relative to a base period.

While there is no doubt that the Sensex stocks are the most liquid (most traded) and well-known ones, one should not forget that it is, at the end of the day, just a basket of 30 stocks. This means the so-called market barometer gives you a picture of only large stocks from about 12 sectors.

Sensex value = Current free-float market value of constituents stocks/Index Divisor

Free float and market value

The market value of a company is determined by multiplying the number of equity shares that it has issued by their market price. This market value is further multiplied by the free-float factor to determine the free-float market value.

To use a live example, the market value of Tata Consultancy Services (TCS) is Rs 103,351 crore since it has 97.86 crore shares having a value of Rs 1,056 (on August 17).

Now, a free-float index such as the Sensex claims to reflect market trends more rationally as it takes into consideration only those shares that are available for trading in the market.

In our example, TCS might have a total of 97.86 crore shares but in reality only 19.57 crore shares are available as the rest are treated as ‘controlling/strategic holdings’. This pegs the free-float factor of TCS at 0.20 (19.57/97.86) and free-float market value at Rs 20,670.20 crore.

So, if you add up the current free-float market values of all the 30 companies, you will get the numerator for the Sensex formula.

about the denominator

The Sensex is calculated using a methodology that focuses upon the base period. Since this base period of Sensex is taken as 1978-79 and the base value as 100 index points — what the index divisor does is to adjust the original base period of the Sensex to its present level. This keeps the Sensex comparable over time.

Calculate Sensex on your own: Find out the free-float market capitalisation of all the 30 companies that make up the Sensex.

Then, add all them. Make all this relative to the Sensex base. For example, for a free-float market capitalisation of Rs 9,00,000 crore, if the Sensex value is 14,500 — then, for a free-float market capitalisation of Rs 9,50,000 crore, the Sensex value will be 15,306. Just use ratios and proportions learnt in junior school!

what moves the Sensex?

Imagine a large joint family living in a big house. This would consist of individuals who represent different generations.

Now visualise what would have happened if all of them were to decide on the family budget. The calculation of the actions that make up the Sensex is no less tricky!

As the Sensex consists of 30 different companies, all of them have different share prices, free-float adjustment factors, free-float market value and weightage in the index. Just like the grandfather in a joint family, the company that enjoys most weightage in the Sensex is Reliance Industries (RIL). Out of the 100 per cent weight of the Sensex, RIL currently has a 13.18 per cent weight.

With the top five companies, in terms of weightage, occupying nearly 50 per cent index — any movements in these five in the same direction could move nearly half of the Sensex!

The accompanying table shows how the index value at any point reflects the ups and downs of the 30 constituents. On August 20, the index gained 286.03 points as five stocks pulled it down while the rest pushed it up.

Importance of weightage: In the chart, HDFC Bank has an index weight of 3.17 per cent — which is less than half of L&T (6.36 per cent).

This is why a comparatively higher Rs 56 increase in share price has effectively contributed to 22.7 index points for HDFC Bank.

On the other hand, L&T, which is two times heavier, has pitched in with 19.1 points with just a relatively lower gain of Rs 49.

Why is Sensex unimportant?

As an investor, you should be aware that though the Sensex is a widely tracked barometer of the markets, your portfolio might not behave like the Sensex at all.

Important sectors such as textiles, BPO services, niche service-oriented companies and segments such as auto ancillaries and consumer durables are not at all represented in the Sensex.

So if you happen to have investments in the other sectors, broader indices such as BSE 200 or even BSE 500 could be better benchmarks, as can the BSE sectoral indices.

Even the most skilled investors assume that when the Sensex tanks by 400 points in a day, the whole stock market reacts…and that all stocks are affected in the same way.

Truth be told, the Sensex captures the movement of 30 stocks, against the 7,000 or so listed companies in India. If the Sensex is down, your investments in a particular company’s shares can actually be unaffected.

Did you know: There are more than 17 companies whose share-prices have actually gained more than 10 per cent in the latest period when Sensex lost more than 12 per cent due to the sub prime crisis fall-out.

More Stories on : Insight | Stock Markets | Young Investor

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page