Many stock market investors would look at stock market indexes (or more appropriately, indices) like the BSE Sensex and the NSE Nifty to benchmark their own investments and to get a sense of how the overall stock market is performing. Investors look at a rising index and see a bull market, or a falling index and see a bear market.
But have you ever stopped to think about what the Nifty and the Sensex are dependent on? How are Nifty and Sensex indices calculated?
In this blog, we’ll look at how to calculate the value of both indexes, and all the related terms.
As you might already know, the Sensex (which is actually an abbreviation for sensitive index), is a collection of the stocks of 30 top companies. These are the largest and most actively traded stocks on the linked stock exchange, that is, the Bombay Stock Exchange (BSE).
Similarly, the Nifty 50 comprises the largest companies listed on the National Stock Exchange (NSE).
Both index values are calculated by comparing the free float capitalization of all the companies with the base value of the index. Some investors refer to the same calculation as float-adjusted and capitalization weighted. Both descriptions refer to the same method of calculation.
How Nifty and Sensex values are calculated:
Let’s look at this float-adjusted and cap weighted method of calculating Nifty and Sensex values step by step.
Let’s calculate market capitalization, which is one of the main components of the formula used to calculate index value.
You will arrive at the market capitalization of each stock by multiplying the present share price by the number of shares readily available on the stock market, also known as outstanding shares.
Now you want to calculate the aggregate market cap of all the stocks in the index. So add up the capitalization of all the stocks, 30 for the Sensex and 50 for the Nifty.
Now you are ready to calculate your free float capitalization. You get this figure when you multiple the aggregate market cap of all the stocks in the index by Investable Weight Factors (IWF) assigned to each stock.
Wait, what is IWF? IWF is a measure of what proportion of stocks is available for free trading on the stock market, versus the amount held by the company’s owners, for example, or any other party that might have a strategic interest in the company. The rationale is that these stocks are most likely not going to be made available for trading on the open market. They are most probably being held with a different game in mind versus the general investor’s typical goal of earning a profit by buying shares at a lower price and selling them at a higher price.
Now you use this formula: Current market capitalization ÷ Base market cap x the value of the related index’s base period.
For Sensex, the specific base period is 1978 to 1979, and its base value is fixed at 100. For Nifty, the base date is the calendar year 1984 and the base value is fixed at 1000.
Base market cap of an index is dynamic and linked to fluctuating stock prices.
Summary and next steps:
Now that you understand what Nifty and Sensex are dependent on – basically, it’s the value and performance of the shares that make up the index that determine its value.
You can now use the value of the index to benchmark the performance of your own portfolio of stocks, or alternatively, you can use it as a barometer to understand how the overall Indian stock market is performing.