What Is Sensex And How Is Sensex Calculated?

How do you know if a particular company’s stock is performing well? Simple - you use a performance benchmark maintained and monitored by professionals for comparison. And in India, Sensex is a market index offering one such yardstick to both beginners and seasoned investors.

But before we get to it, let us first understand what a stock market index is.

A stock market index is a statistical measurement of the ups and downs of a group of stocks or assets. It essentially measures the changes in the group’s stock prices over a specific period.

Now, what is Sensex?

Think of Sensex as a numerical progress report for 30 of the most actively traded and financially stable company stocks listed on the BSE Limited.

Each of the 30 stocks belongs to a highly influential company and represents India's major industry/sector. The BSE Sensex value increases or decreases as and when the stock prices of these 30 companies fluctuate with changing economic cycles.  

To simplify further, the index reflects the overriding sentiment of the market participants (investors/traders), the market's equity health, and the broad state of the Indian economy. If the participants believe the economy will do well in the coming term, they will trade more actively and increase the index. 

Should the participants feel the opposite happening (economic slowdown), they will likely pull out of the market or stop investing/trading actively. This can cause BSE Sensex to plummet by a few points. 

Just consider the current market scenario. For a while now, investors have been speculating a bumpy ride for the Indian economy, given the rise of global inflation. This is indicated in the BSE Sensex's volatile performance at the beginning of June. 

On 6th June 2022, Sensex was at 55,675.32 when the market closed – down by 93.91 points or 0.17%. And only seven days before, the index had touched 55,785.70 after gaining 1,079.02 points on 30th May 2022 due to a rally of technology stocks. 

So you see, this is how the economic events recast the Sensex index. Its value directly reflects the true composition of the market at a given time. That's why knowing what Sensex’s performance over a specific period is can tell you a lot about the country's economic health and where to invest your money.

Now, a few questions remain. 

• First off, how are the 30 stocks pre-selected for the index?
• And secondly, how is Sensex calculated?

Let's dig a little deeper to answer these. 

1. How does BSE choose the 30 stocks?

The 30 company stocks which collectively form the 'market index' are called constituents of the Sensex. They’re selected using the following criteria:

• Firstly, all the stocks must be listed on the BSE to be eligible for index inclusion. But the minimum listing history has to be at least six months.

• The stock should have a greater degree of liquidity for easy trading. 

• The company should be classified as mid-sized or large according to the market capitalization. Or, simply stated, it should belong in the top 75 companies based on total market cap (value of company's shares held by outside investors and corporate insiders)

• Lastly, the company should have a well-balanced sector weight. The larger the cap size of the company, the bigger its weight is in the index. 

However, all the constituents of the Sensex index are not set in stone. They are revised biannually in June and December every year. 

2. How is Sensex calculated?

BSE Sensex is calculated using the Free Float Market Capitalisation (or the float-adjusted capitalization) method. If we break down the terminology, we get two key components:

Free float, or floating shares, is the number of a company's outstanding shares open to trade publicly.

Market capitalization, or market cap, is a company's aggregate value calculated based on its number of outstanding stocks and current share price. So, if a company has 12000 outstanding shares priced at Rs. 50 each, then it will have a market cap of Rs. 6,00,000.

So, how is Sensex calculated using the two concepts? 

Since the method only involves free-float shares, the company's privately-owned shares or those owned by the government and promoters are ignored. This is why the company's free-float market cap value is less than its actual market cap value. 

Now, let's take some examples to understand.

Assume two companies, A and B, are listed on BSE with outstanding shares of 10,000 and 15,000, respectively. And each share is priced at Rs. 100 while the Sensex is 50,000 points at the moment.

Free float market cap of A = (10,000 x 100) = Rs. 10,00,000

Free float market cap of B = (15,000 X 100) = Rs. 15,00,000

Total market cap = Rs. 25,00,000

But what happens when A's share price comes down to Rs. 90 and B's share price increases to Rs. 120 the next day?

The new total market cap = Rs. 27,00,000. As a result, the market cap of BSE rises by 8%, and the new BSE index value reaches 32400 points. 

To summarise

The S&P BSE Sensex index indicates the movement of a select group of stocks listed on BSE. It tracks the movement of prices and changes the index value to provide a numerical representation of the same.

Now you know what the Sensex index is, how it is constructed, and how to evaluate it. You're now better informed to make sound investment decisions. So, start investing. Download Tata Capital’s Moneyfy app and explore India’s top-rated equity funds, index funds, and more.