There are two significant parameters that experts use to weigh and analyse the state of a nation’s economic and financial health. One is the GDP – Gross Domestic Product – the monetary measure of the market value of all the final services and goods made in a specific period.
The other is the financial performance of a company’s shares – stock market indices. But, some questions arise – which companies matter in a stock market index? Are all companies included in the performance analysis of market indices? And what exactly is a market index?
Stock market index – which companies matter?
By definition, a market index is a portfolio of investment holdings representing a financial market segment. The market index value is calculated from the prices of the underlying holdings. The market index analysis helps identify if the market is up or down (and also shows the economic growth or decline). Indices are the report card of the market’s top companies’ performance in the market.
‘‘
If not the biggest by size, each sector's top and leading companies are included in making a market index.
Companies with considerable value in their respective industries are basically the ones accounted for in the analysis by a market index. For example, Indian companies with significant market shares, such as Infosys, Tata, Reliance, Hero, etc., represent the entire market in a stock market index.
It is important to note that not all companies listed on a stock exchange are included in making a stock market index. For a reference point, the Bombay Stock Exchange has 5000+ companies listed on it. Out of those 5000+, only the top 30 companies are considered based on their market capitalisation.
What is market capitalisation?
Market capitalisation (market cap) is the total market value of a company’s shares of stock. It is calculated by the product of the total number of a company’s shares and the price per equity share. In calculating the market cap, promoter shareholdings are not included.
For example, suppose Reliance (RIL) has 10,00,000 shares in the market. If out of those 10 lakh shares, 3 lakh are owned by promoters (say, the members of the Ambani family and relatives), then the market cap will be calculated only for the rest 7 lac shares and not for those held by the private promoters.
The publicly traded shares, i.e., the shares held by public shareholders, give the free-float market capitalisation. This shows that the total market cap and free-float market cap can be different.
SENSEX and NIFTY50 – The indices of the BSE and NSE
Based on the free-float market cap, the top 30 companies are shortlisted on the Bombay Stock Exchange (BSE) from different sectors. The base year for calculating the average of the companies’ points is 1978-79. The points calculation started from 100 points, and the collective standard of the top thirty companies on the BSE is called the SENSEX (S&P Bombay Stock Exchange Sensitive Index).
In the National Stock Exchange (NSE), the top 50 companies are included based on their free-float market cap to make the NSE stock market index – the NIFTY 50 index. Companies in NIFTY 50 (NSE Index) do not remain constant but keep changing as per their free-float market capitalisation.
What does it mean when the market is up or down?
Suppose the SENSEX is at 28000 points, and it falls in points to 27900. This fall of 100 points will indicate that a majority of those 30 companies are not doing well at share prices. And this is what is known as the ‘market is down’ situation. The reverse situation (a rise to 28100) will be called a ‘market is up’ situation.
When the index is down, i.e., the market is down, it indicates that companies accounted for in the index are making less profit and development. Thus people are not buying the shares or are selling the existing ones.
For a reference basis, before the 2008 financial crash, SENSEX was at a high of 21,000 points. But after the crash and recession, it came down to 8000-9000, showing a severe loss of points and top companies’ average share valuations.
Bull and Bear markets
If the market is down, it means people (investors and shareholders) are selling their shareholdings. When the index is up, i.e., SENSEX or NIFTY 50 are up, it points towards good economic growth and stock market activity.
Colloquially, it is called a bull market when the market is up, meaning that investors are buying. When the index is down, selling shares takes place faster than buying; it is called a bear market.
It is therefore clear that the stock market index is critical to see the state of a market. That is why, when the Government of India announces the national budget, the market indices witness a lot of activity. If the budget is positive for the market, then the market registers a high growth in index points and vice versa.
Interestingly, the first Index – BSE SENSEX – was first started in India in 1986 and NIFTY 50 was established in 1997. Both have been recorded continuously since then, helping investors analyse market trends, companies make profit valuations, and economists see the health of the Indian economy.
