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Stockmarkets: Making sense of the Sensex... - Views on News from Equitymaster
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  • Sep 1, 2004

    Stockmarkets: Making sense of the Sensex...

    There is hardly a single day when stock markets are not talked about. Even those who do not actively participate in equities do keep their ears open and passively follow market movements. Every day, across television news channels, finance portals and newspapers, one would more often than not come across a headline, which either states, "market is up" or "market is down". So, what is this 'market'? What does the media refer to when they talk about 'market'? Well, while everyone is aware of the fact that the word 'market' is related to stock markets, generally, the word 'market' seemingly implies an 'index'. Again, the reference here is generally made to the benchmark index, which in the case of India is the Sensex (Bombay Stock Exchange or BSE). In this article, we try to throw some light on various aspects related to the BSE-Sensex.

    The Bombay Stock Exchange (BSE) has a history dating back by 128 years. Since then, the Indian stock markets have evolved gradually over the decades and are today seemingly one of the more efficient markets in the world in terms of technology and settlement systems. However, it must be noted that till the mid-eighties (1980s) i.e. over a century since its establishment, the BSE did not have a definite and formula based scale to measure stock market movements. This necessity gave birth to the Sensex (BSE-30), which is a basket of 30 companies representing different sectors of the Indian economy. The index was pegged at base value 100 on the base year 1978-79.

    It must be noted that the Sensex is a good barometer of the Indian stock markets, which in turn is a good enough indicator of our economy, not just in the sense as to what our economy has been in the past but also as to how it is likely to behave going forward. Further, the importance of the Sensex is enhanced further when one considers the fact that the aggregate market capitalisation of all the 30 companies that form the Sensex taken together forms approximately 50% of the total market capitalisation of all the companies listed on the Indian stock markets (as at the end of August 2004). Considering these aspects of the Sensex, it becomes an important part of an investor's life as the broader behaviour of this would determine whether an investor is likely to be rewarded for this additional investment (into equities) risk of his.

    It must be noted that there are over 6,000 stocks that are listed on the stock markets and it is practically impossible to track the performance of all these companies and this, gave another reason to form a representative of all the companies listed on the bourses. Here, it is not difficult to fathom the fact that the BSE authorities, who are entrusted with the task of selecting the 30 stocks representing the index, must not only be having a great sense of responsibility but also some foresight of the constantly changing dynamics of the Indian economy.

    To put things in perspective, let us just briefly go through the selection, qualification and review process of the Sensex constituents (as described on the BSE website). To begin with, transparency and simplicity of a company forms the basic objectives of selection. The Index Committee meets every quarter to review all the BSE indices including the Sensex. However, every meeting need not necessarily result in a change in index constituents. Just to put things in perspective, since 1986, when the Sensex was formed, the Sensex has been re-shuffled only 11 times.

    Further, apart from the average market capitalisation factor of the company (which must be amongst the top 100), trading frequency (every day in last 1 year), average daily trades (amongst top 150 in last 1 year) and average daily turnover (amongst top 150 in last 1 year) form the other parameters, which a company's scrip should satisfy in order to qualify for selection. Last but not the least, not only would the companies selected take into account a balanced representation of the all the stocks listed on the Bombay Stock Exchange, the selected should be leaders in their respective industries.

    While there would always be debates with respect to the representation/weightages of various sectors (e.g. oil & gas, telecom, FMCG, etc) on the Sensex and also that of the weightage of the broad constituents of the economy (agriculture, manufacturing and services), the selection, qualification and review process of the BSE Index Committee does instill a sense of confidence in the quality of companies that form a part of the Sensex. However, the caveat here is that despite all the precautions that the authorities take, nothing can be guaranteed as regards to the future growth prospects of the companies in the index. However, if the past is any indication, just to put things in perspective, if we take FY79 as the base (100), the Sensex has since then appreciated at a CAGR of 17% to the current index levels of 5,200!

    From an investors' point of view, it must be noted that the Sensex companies are amongst the most widely researched and widely held companies, not just by retail investors, but also by institutional investors - both domestic and international. Further, considering the fact that access to information about these companies is easy and also that these companies are generally blue chips, which have stood the test of time with strong and viable business models and trustworthy managements, investments in these become a relatively safer investment approach rather than looking for big gains in the small and under-researched stocks.



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