How Sensex is Calculated?

Since my early days of involvement in the stock market, I was intrigued by the number called Sensex (A BSE Index). I always wanted to know how Sensex is calculated. What is fascinating about Sensex is that, when it is rising or falling, almost all stocks (mainly good ones) seems to follow its trend.

I started investing in the stock market in the year 2008. During that time, Sensex crashed more than 50%, from 20000 to 9000 points. The cause of the crash was the subprime mortgage crisis in the US. When the index fell, even large stocks crashed heavily.

Sensex’s rise and fall getting replicated by other stocks was a surprise for me. I wondered, what is the correlation between Sensex and individual stocks. The answer I got while researching about “how Sensex is calculated”.

I will share my finding in this article.

About BSE and Sensex

Before the COVID crash of 2020, Sensex was at 41,170 points (20-Feb-2020). Today (23-Aug-21) value is around 55,508 points. We keep seeing these numbers on our Screens. What are these numbers, how it is calculated? That is what we will decipher here. But before that, an interesting historical fact about the BSE.

Sensex is the main index of BSE (Bombay Stock Exchange). Not many people know that the Bombay Stock Exchange is the 10th oldest stock exchange in the world. It is also the oldest stock exchange in South East Asia. BSE got established by Premchand Roychand in the year 1875.

Premchand Roychand was a Surat-born, Bombay-based stockbroker and businessman. He was among the founders of “The Native Share & Stock Brokers Association.” This association is now called BSE (Bombay Stock Exchange).

All stock markets have their index. Like, for USA Stock Market is S&P 500 and NASDAQ. For the London stock exchange, it is FTSE100, and for India’s NSE, it is Nifty.

Similarly, for the second-biggest stock exchange of India (BSE), the main index is called Sensex. It is an acronym for the Sensitive Index (Sensex).

More About Sensex

Like Premchand Roychand, Deepak Mohoni is another new name related to BSE/Sensex. Though not many people will associate him with Sensex, he is the one who coined the term Sensex for the BSE’s main index. 

Deepak Mohoni used to write columns for Economic Times till 2012. There he was described as an “independent technical analyst.” He is a 1975 graduate in B-Tech from IIT-K and a 1977 MBA from IIM-C.

National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) are two major stock exchanges in India. Their main index is Nifty and Sensex, respectively.

These indices are composed of 50 stocks (Nifty) and 30 Stocks (Sensex). For an analogy, you can imagine a mutual fund portfolio. Like this portfolio has a list of stocks, our indices also have a few as their constituents. The Sensex number (like 41,170 or 55,508) gets quantified using market capitalization data of its constituent stocks.

Sensex Listing Criteria

There are a few criteria based on which a stock becomes eligible for getting listed in Sensex. Among all other criteria’s the most important one is market capitalization. If a share is not among the first 100 stocks by market cap, it will not become eligible.

Furthermore, it is also imperative to include a variety of stocks in the index. The idea is that the constituent stocks together shall function as a representative of all sectors/industries of the market. They must reflect the sentiment or mood of the overall market.

In the BSE, about 4000-5000 numbers of active stocks are listed and traded each day. The selected Sensex-30 companies represent all the listed stocks. 

How Sensex is Calculated?

Following are the seven steps involved in the calculation of Sensex.

Watch the video explaining the seven steps.

• Step#1: First, we must list all 30 stocks which form the constituent of Sensex. To know the list of 30 shares and their weight in Sensex, check this article.
• Step#2: We must then note down the full and free-float market cap of these companies. We can get these numbers from the individual stocks pages on BSE’s website.

• Step#3: Once the full-market cap and free-float market cap of all 30 stocks are known, we can now calculate the free float multiple for each constituent. Do it by dividing the free-float market cap by the full-market cap. This number will be mostly below one (1). For some companies, its peak value will be one.

• Step#4: The free-float market multiple is rounded off as per the following table. Suppose a stock’s free float multiple comes out to be 0.28. Then as per the table, its free float factor to be used is 0.3 for Sensex calculation.

• Step#5: Now, recalculate the free-float market cap using the revised free-float factors (see above). The revised free-float market cap will be a full-market cap multiplied by the free-float factor.
• Step#6: Now, calculate the sum of the free-float market cap of all 30 stocks. This value will be our total free-float market cap.
• Step#7: It is the final step. We will have to use a formula to calculate the Sensex. It looks like this:

The Sensex Formula

In the above formula, there are three components:

1. Total Free-Float Market Cap: This is the value we have calculated in Step#6 above.
2. Base Year Index Value: The base year for Sensex is considered as 1978-79. In 1978-79, the Sensex is assumed to be at 100 points (the present number is about 55,000 points).
3. Base Year Market Cap: A number for base year market cap must be calculated. How to do it? Frankly, I do not know. Neither it was available on the BSE India’s website. But I assume that this value must be around 11,473 crores.

Considering these assumptions and the Sensex formula, today’s value of Sensex will be about 55,000 points.

Conclusion

In the year 1979, the Sensex is assumed at 100 points. It means in the next 42-Years the Sensex rose from 100 points to 55,500 points (today). It means it grew at an annualized rate of 16.24% per annum. 

At growth rate of 16.24% per annum, Rs.1 lakhs invested in Sensex in 1979 will become Rs.5.55 crore today (2021).

The assumed value of Rs.11,473 Crore as the base year market cap is unconfirmed. But I think it conveys the point about how Sensex is calculated. I tried to get the confirmation from BSE India’s website, but I could not get it. What was available there was a mention of Index Divisor without disclosing any numbers. So that was not helpful.

Hence, I thought to proceed with my assumed number. I thought at least the calculation methodology will get exemplified.

I hope you liked the article. Please leave your feedback in the comment section below. Have a happy investing.