SENSEX Calculation ‐ No Rocket Science

We normally talk or hear about the movement of sensex very often. Maybe our parents,
relatives, collegues or friends talk about it. If none of these are interested than there are news
channel flashing 24x7 news about the sensex, giving out the reasons for its upward or
downward movement.But not all of us must have wondered that how is Sensex calculated. If for
example ,we say that the sensex closed at 18000 points today, higher by 500 points from
previous close than how both these figures are computed and how this figure reflects the mood
of the economy.

Lets now clear that doubt in our mind and completely understand the whole concept of sensex
from its inception in 1986 till the time you are reading this article in a simple, easy and
understandable language with examples.

Before moving ahead, lets first look at the meaning of two important terms that will be the core
of our discussion. First is Full Market Capitalization and the other is Free Float Market
Capitalization.

Full Market capitalization is the total value of the tradable shares of a publicly traded company.
It is equal to the share price multiplied by the number of shares outstanding of that company.
So for example, if the share price of Reliance is Rs 10 and the company has total 1000 shares
outstanding, than the market capitalization of reliance will be Rs 10,000 ( 1,000 *Rs 10). On the
other hand, Free float market capitalization is the total value of a publicly traded company
excluding the shares held by the promoters. So if in the above example ,promoters of reliance
holds 400 shares out of the thousand shares of the company than the Free Float market
capitalization will be Rs 6000 i.e.( 1000-400)*Rs 10.

The Index was initially calculated based on the "Full Market Capitalization" methodology but
was shifted to the free-float methodology with effect from September 1, 2003. Sensex is
computed on free float market capitalization method because it is assumed that the shares held
up by the promoters are locked and are not available for day to day trading. There are certain
criteria's to determine the promoters holding and the company is required to update this
information quarterly with the stock exchange.

Let's now begin with the concept.

Sensex is an abbreviation of the word Sensitive Index - the benchmark index of the Bombay
Stock Exchange (BSE). It is composed of 30 of the largest and most actively-traded stocks on the
BSE. Initially compiled in 1986, the Sensex is the oldest stock index in India. The base year of
Sensex is 1978-79 and the base value is 100. These 30 companies in the Index keeps on changing
as per the guidelines of the exchange and reflects the general trends of all the companies and
the economy as a whole. So you must have guessed by now that the selection of these companies
are from diverse industries and selected on fulfilling certain criteria's of the respective
exchange. So if Reliance industries is selected to be a part of index than the reason is because it
will represent the entire oil & gas industry due to its huge market share and Influence. It must
also be noted that reliance industries is not permanently a part of index and may be removed
from the index if it fails the eligibility criteria. Any other company which fulfils the criteria will
be then made the part of index.

Although the index was introduced in the year 1986,its base year was taken to be 1978-79. So at
the time when sensex was started in 1986, 30 eligible companies were selected and on the basis
of there prices, market capitalization was calculated (remember , M-Cap is price multiplied by
the total shares outstanding ) and it was said that at this market capitalization, sensex is 100.
After that, movement of sensex is being reported on the basis of price fluctuations in these 30
companies taking the base value as 100. So If the share price of most of the company increases
than the total market capitalization also increases and ultimately the sensex increases ,same
thing happens vice versa as well.

Lets understand this with the help of an example.

Free float
Total no.of No of Free price of Total Market
Company market
shares float shares shares Capitalization
capitalization

Reliance 1,000 800 20 20,000 16,000

Tata 2,000 1,600 30 60,000 48,000

Infosys 3,000 2,400 40 120,000 96,000

Airtel 4,000 3,200 50 200,000 160,000

SBI 5,000 4,000 60 300,000 240,000

15,000 12,000 700,000 560,000

In this example, reliance has 1000 shares outstanding in its balance sheet and out of them 800
shares are with general public and the balance 200 shares are held by the Ambani family,
similarly 1000 shares of SBI are held up with the government and the balance are in public
domain. We calculated both the total as well as free float market capitalization but will use later
one for SENSEX computation. So now lets assume that the market capitalization in the year
1978-79 was 1,00,000 and as previously discussed ,sensex at this level was 100 .On the basis of
this market capitalization , we will calculate the index again for the revised M-cap. Therefore
the revised Sensex will be computed as follows:

New market 560000*100

Cap * 100 i.e. = 560
Old Market Cap 100000
Hence, the sensex will move upward to 560 from 100, it should be noted that practically this
process is done on real time basis and the revised Sensex is computed every 10 seconds. It
should be noted that Bombay stock exchange was in existance from past 100 years and the
companies were also listed in it much before the year 1986.It was only that the trends in the
stock market were not measurable and therefore the Sensex was introduced to Measure the ups
and down in the Indian stock market.