What Is Sensex And What Does It Mean For Your Investments

Are you amongst those who flips past the newspaper's market section because of financial 'jargon'? If yes, then one word that surely occupies headlines nearly everyday, is Sensex. Ever wondered why the ups and downs in Sensex are always the talk of the town? Let¡¯s clear the air and tell you what it is, and how it affects your investments.

What is Sensex?

The term Sensex, also known as BSE SENSEX, comprises of two words - Sensitivity and Index, which are indicative of what Sensex reflects and calculates, i.e. the movements in the BSE. Sensex is the stock market index for BSE (Bombay Stock Exchange), which was founded in the year 1875, making it the first stock exchange of India and the oldest one in Asia, besides being the Fastest Stock Exchange in the world. Also known as BSE SENSEX (Founded in 1986), it is a free-float market-weighted stock market index that aggregates the movements of 30 well-established and financially sound Indian companies. These 30 companies are some of the largest and most actively traded stocks, and are representative of various industrial sectors of the Indian economy. In simpler words - the Sensex tracks the price movements of the 30 biggest publicly listed companies in India.

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How are SENSEX constituents decided?

Broadly stating, there are 4 key criteria that each company has to fulfil in order to be considered for inclusion in SENSEX, which are as follows:

1. Must be listed on Bombay Stock Exchange (BSE)

The company aiming for inclusion in SENSEX has to be listed on the Bombay Stock Exchange. If it is not listed on BSE, then it cannot be a part of SENSEX too.

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2. Must be a large or mid-sized company

For gaining eligibility for inclusion into SENSEX, the company must have a large-to-mid size market capitalisation. Presence of this criterion is what enables SENSEX to have only the best and biggest companies as a part of the index.

3. High liquidity of shares

For a company¡¯s stock to be considered for inclusion into SENSEX, it has to possess a high degree of liquidity. Simply put, it should be easy to buy as well as sell that particular stock. Moreover, as this liquidity is a part function of the quality of the underlying business of the company, this also acts as a filtering criteria to ultimately allow only those companies whose business quality, and therefore their shares¡¯ liquidity, is high.

Core activities should constitute a substantial portion of revenue - Another criterion put forth for a company to get included in SENSEX, is that its core activities of business should contribute a substantial revenue. Numerous companies have been classified into different sectors according to their core activities, depending on what kind of business the company is into.

4. Sector Weight of the company

Another vital criteria is sector balancing, i.e the SENSEX constituents have to keep the sector balanced broadly in line with the Indian equity market. For any particular index, every sector has a designated weight attached to it, which represents the economy. For example, financial services usually have the maximum weightage for different indices. So, every company has to necessarily maintain the balance of the sector to which it belongs, even after getting added to the list of 30 companies included in SENSEX.

Also, each of the constituents of SENSEX holds a different weightage, which is decided according to free-float market capitalisation.

What¡¯s the frequency of calculation in BSE SENSEX?

During stock market hours, prices of the index securities at which trades are executed, are automatically used to calculate the BSE SENSEX every second and also continuously update on all trading workstations connected to the BSE trading computer in real time. Also, each day's opening, high and low prices are also given by the BSE trading computer. However, the closing prices are calculated using the spreadsheets in order to ensure theoretical consistency.

How Sensex is calculated?

First the 30 stocks are listed, which have to be included in the SENSEX as per the criteria set, then the market capitalisation of all the 30 companies are determined. Post that, the Free Float Market Capitalisation of all the 30 companies is determined, and eventually summed up for all 30 companies to arrive at the total of all the Free Float Market Capitalisation. Remember that as per Free float methodology, the level of index at any point of time reflects the Free-float market value of 30 component stocks relative to a base period.

Free-Float Market Capitalisation = Market Capitalisation X Free Float Factor

Free Float factor is referred to as that % of the total shares issued by the company that is readily available for trading in the market. It excludes the shares that are held by the promoters, government, etc.

And market capitalisation represents the valuation of the company. It is determined by multiplying the price of a stock with the number of shares issued by that company.

Now, the formula of Sensex = (total free float market capitalisation/ Base market capitalisation) X Base index value. The base year to calculate Sensex is 1978-79 and the base index value is 100.

How to invest in SENSEX?

There are two ways to invest in SENSEX-

First is by buying stocks directly in the same percentage as weightage in SENSEX. Herein, you can directly start investing in the constituents of the SENSEX and the weightage they have in it. Simply put, you can directly buy the stocks in the quantity which is equivalent to the stock¡¯s weightage in the index.

Second way to invest in SENSEX is through Index Mutual Funds. These mutual funds replicate the index i.e, they have a portfolio exactly like the index. So a SENSEX based index fund will have the 30 stocks in the same proportion as the SENSEX. Index funds are passively managed funds, implying that the fund manager invests in the same securities as present in the underlying index, i.e. SENSEX in this case, and also in the same proportion. The fund manager doesn¡¯t change the portfolio composition, and the fund aims to offer returns comparable to the index that it tracks and aims to mirror.

Objectives of BSE Sensex

1. To measure market movements

Thanks to its long history as well as wide acceptance amongst individual investors, institutional investors, foreign investors and fund managers, no other index matches BSE SENSEX in reflecting market movements and sentiments. It is thus, widely used to describe the mood in the Indian Stock market.

2. Benchmark for Funds Performance

The inclusion of Blue chip companies coupled with the wide and balanced industry representation makes SENSEX the ideal benchmark for fund managers to compare the performance of their funds.

3. For Index Based Derivatives Products

Small investors, Institutional investors and money managers refer to the BSE SENSEX for their specific and varying purposes. Since SENSEX comprises of leading companies in all the significant sectors of the economy, it is believed to be the most liquid contract in the Indian market and expected to garner a pre-dominant market share.

What do SENSEX movements indicate?

Simply put, if the Sensex climbs up, it implies rise in the prices of the stocks of most of the major companies listed in the BSE. On the contrary, if the Sensex goes down, it indicates that the stock price of most of the major stocks listed on the BSE have gone down.

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