Simplified Finance Series: 1

SENSEX

“Packaging (Sensex) is just a virtual show-window of a product (Stock Market) and not its fact-file”.
Appearances can often be illusionary and deceptive. This is especially often true in case of Equity Stock
markets where unusually there is a higher demand even as prices go on rising. SENSEX is the talk of the
town especially after it has crossed 20000. However very few investors have understood it in detail.
Often SENSEX is given undue weightage leading to impulsive and irrational investing. Investors follow a
HERD mentality inevitably suffering severe financial losses. The present article seeks to demystify the
SENSEX & debunk some myths surrounding it.

1. What is the Sensex?

Ans: The BSE Sensex (Sensex as it is popularly known) is a Sensitive Index which tracks price movements
of 30 stocks on the Bombay Stock Exchange (BSE).

2. How are these stocks selected?

Ans: Top 30 companies with highest Free Market Capitalisation are selected as the sample size. Free
market capitalisation considers only the free float i.e. shares available for trading. It excludes the locked
in shares (those issued to promoters and other strategic investors which cannot be traded), from the
total no of shares issued by the Company.
Free Market Capitalization = Total shares available for trading X Current Market Price
As can be seen from the formula, it is dynamic due to change in market price every minute.

3. Who formulates/updates the SENSEX?

Ans: BSE reviews the list of stocks periodically . This essentially means that some stocks are moved out
of the SENSEX calculation and some are brought into the list of 30 after every review. The sample of
stocks included thus reflects the current Top 30 stocks in terms of Free Market Capitilisation.

4. Is each of these 30 stocks given equal weightage?

Ans: No. Each individual stock is given a weightage as per its market capitalisation.
5. What does the SENSEX level of 20000 signify?
Ans: The base value of the SENSEX is 100 as on April 1, 1979. The level of the SENSEX at any point of
time thus reflects the collective free float value of the 30 component stocks, relative to the base
period. For example a SENSEX level of 20000 indicates that the Capitilisation of the current Top 30
stocks is 200 times the Capitilisation of the Top 30 stocks as of the base year.

It needs to be noted that the SENSEX is the most tracked & talked about but the least understood. Some
analysis is given below debunking some prominent myths.

Myth 1: SENSEX mirrors the performance of all the sectors in the Economy
SENSEX does not have any sectoral allocations and therefore is not a representative of all the sectors in
the Indian economy. In fact it is heavily biased towards three sectors Oil & Gas, Financial Services and
Information Technology which have a combined weight of more than 50% in the Index. Also some
sectors are not tracked by the SENSEX for e.g. Aviation, Aquaculture, Diamond & Gems Processing etc.

Myth 2: SENSEX is a true indicator of the Indian Economy’s Growth

Often the rise or fall in the SENSEX is taken as a macro economic indicator. This is not correct as the
SENSEX only tracks the listed Companies listed on the Bombay Stock Exchange.
Many of the Indian firms are proprietary, partnerships or micro units which are not eligible for listing on
a Stock Exchange. Also many bigger Indian Companies prefer not get listed. Of the 2,70,000 odd firms in
India, hardy 3500 are listed on the BSE. Thus only a small proportion of the Indian firms are listed.
SENSEX therefore does not mirror entire Indian economy as a whole.

Myth 3: SENSEX tracks the performance of all Companies listed on the BSE
This also is false as the SENSEX tracks only a small sample of 30 listed Companies with the highest
Market Capitalisation, compared to the approximately 3500 companies listed on BSE. SENSEX thus
tracks only a small representative of the entire population of listed stocks and therefore does not reflect
the market movement as a whole. Often even though SENSEX registers an increase in value, many listed
individual stocks may have lost value. In fact on Sept 21, the day SENSEX touched 20000, 2123 out of a
total 3113 Companies (i.e. roughly 70%) declined in value over the previous day at the end of trade.
Myth 4: SENSEX captures the stock price movement of all these selected 30 Companies
This again is not true as the 30 SENSEX stocks are not given equal weights but are given individual
weights based on their Free Market Capitilisation. On an individual basis Reliance Industries Ltd., which
currently has a weight of 12% to 13% would influence the SENSEX more than ACC which has a weight of
only 0.6 to 0.7 % .
The top 10 stocks have a combined weight age of more than 65% in the SENSEX. The rise and fall of
these 10 stocks thus influence the SENSEX considerably more than the bottom 20 Stocks. Often SENSEX
rises in value due to a rise in market prices of the stocks with large weights irrespective of the price
movements of the other low weighted stocks.
Again on Sept 21, 14 out of the total 30 stocks in SENSEX actually lost value during days trade (a
significant 47%).

Myth 5: Investment decisions of Institutional Investors are based only on SENSEX

Wrong again. Only if an investor has invested in stocks comprising the SENSEX and in exactly the same
proportion then it makes sense to track it. However this is rare and happens only in case of Index Mutual
Funds, Exchange Traded Funds etc.
Though institutional investors consider the level of SENSEX before investing, there are various other
factors too. Most of them follow the EIC (Economy, Industry, and Company) approach. They are
primarily concerned about the macroeconomic fundamentals, the stage of the Life Cycle of the Industry
and the individual Company’s prospects. Also they track the prices of individual investments rather than
the SENSEX levels on real time basis, to gauge the performance of their portfolio.

Conclusion:
Summarizing, SENSEX is not an unbiased true indicator of the 30 Index stocks let alone the entire
Stock market and Indian economy
Investors should not rush into investing in the stock markets and should look at other fundamentals
before investing. Those who have invested in stocks which are not in the list of 30 SENSEX stocks should
concentrate on the stock price movements of the portfolio. They are advised not to get unduly
influenced just because the SENSEX is on an upward move (the so called Bull Run). Many Investors have
lost their shirts, and incumbent Governments have lost elections due to this misleading illusionary
“Shining” effect.
Simplified Finance Tools: Ask the following logical questions for any INDEX:
Q1) What does it seek to measure? (Details of population)
Q2) What does the sample comprise of? (Details of the sample size and weights)
Q3) What is compared with? (Details of base year and period of comparison)

Prof anil menon interacts with students of Family Managed Business of S.P. Jain in the area of Finance
and can be contacted at anilrmenon1@simplifiedfinance.net