What really does the Sensex measure?
The Sensex, first developed as a share price index for the Bombay Stock Exchange (BSE) in 1986, is aimed at capturing the overall level of prices in the market based on 30 of the largest, most liquid and representative scrips available on the BSE. While it is a price index, what it really measures is the free float market capitalisation of its 30 constituent scrips in relation to the base period of 1978-79, which is equated to 100.
What does market capitalisation mean?
It is simply the value of all the shares that a company has at the current market price. In other words, it is the price of each share multiplied by the total number of shares available.
What is free-float?
The free-float of a scrip is the proportion of total shares issued by the concerned company that is readily available for trading in the market. It excludes the promoters' holding, governments holding, strategic holding and other locked-in shares that will not normally be available for trading in the market. In essence, the free-float is the proportion of a companys shares that is readily available for buying or selling.
What are the advantages of using free-float market capitalisation for the Sensex?
Since the idea behind the Sensex essentially is to capture the movement of the market, it makes more sense to look at shares that are actually available for trading than all the shares of a company. For instance, consider a situation in which the share prices of company A and B both increase by Rs 10 on two different days. Now assume that company A has one crore shares whereas company B has two crore shares. If total market capitalisation were taken into account, the day on which company A's price moved up would have increased market capitalisation by Rs 10 crore, whereas on the other day the increase would have been Rs 20 crore. The Sensex should then increase more sharply on the latter occasion. Now suppose that only 10% of company B's stocks are in free-float, while 40% of company As are on free-float. In that case, on the day that company B's price moved up by Rs 10, only 20 lakh shares available for trading would have seen a price increase that the market could take advantage of. In company A's case, on the other hand, as many as 40 lakh tradable shares would feel the impact. Clearly, for the market the latter is more of an impact.
Are the 30 scrips always the same?
Not at all. There are constant revisions as some scrips become more liquid or become among the ones with the highest market capitalisations and so on. In the current year itself, for example, L&T moved out of the Sensex in May with Maruti Udyog Ltd coming in to replace it. Later, in September, L&T was back as part of the Sensex, replacing MTNL.
Who decides which scrips will comprise the Sensex?
The Bombay Stock Exchange has an Index Committee consisting of a mix of academicians, fund managers from leading mutual funds, journalists, market participants, independent governing board members, and the exchange administration. The responsibility of keeping the Sensex in tune with the changing reality of the market lies with this committee, which has laid down quantitative and qualitative criteria to use in deciding when to exclude or include a particular scrip. The committee meets every quarter to review the Sensex as well as the Bombay Stock Exchange's other indices, though changes need not result from every meeting. When the committee does decide on a change, it announces six weeks before the actual replacement which scrip or scrips will go out and which will come in to replace them.
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