How Is the Sensex Calculated? Free-Float Market Cap Explained

The Sensex is an important indicator of the Indian stock market. Investors pay attention to the share prices of the big firms when it goes up or down. However, the Sensex is not determined by adding up their share prices. It does so by a method called free-float market capitalisation, that is, the value of shares which are available for trading. By knowing this technique it would be easier to comprehend the market movements and understand the Sensex value.

What Is the Sensex?

The Sensex or S&P BSE Sensex is a stock market index that includes 30 well-established and large companies listed on the Bombay Stock Exchange (BSE). These companies are in various businesses, which provides a wide spectrum of investors’ knowledge about the performance of some of major businesses in India. For beginners planning to open Demat account facilities, understanding how the Sensex works can provide a useful starting point for learning about the stock market.

These companies are part of the Sensex, and changes in their share prices affect the index. However, not all companies have the same impact. Companies with a higher free-float market capitalisation receive greater weight in the index than those with a lower free-float market capitalisation.

This is why the Sensex can rise even when some of its constituent stocks fall. Its overall movement depends on the combined performance and weight of all 30 companies.

What Is Free-Float Market Capitalisation?

Market capitalisation is the total market value of a company’s issued shares. It is calculated by multiplying the current share price by the total number of shares issued.

For example, if a company has 100 crore shares and each share trades at ₹200, its total market capitalisation is ₹20,000 crore.

However, all these shares may not be available for regular trading. Some may be held by company promoters, governments or strategic investors. Free-float market capitalisation considers only the shares available for public trading, based on the applicable free-float factor.

Formula:

Free-float market capitalisation = Total market capitalisation × Free-float factor

For instance, if a company has a market capitalisation of ₹20,000 crore and 60% of its shares are available for trading, its free-float market capitalisation would be ₹12,000 crore.

This method gives more weight to the portion of a company’s shares that can be traded in the market.

How Is the Sensex Calculated?

The Sensex calculation follows a few steps:

1. Calculate the market capitalisation: The share price of each of the 30 companies is multiplied by its total number of issued shares.

2. Apply the free-float factor: The market capitalisation of each company is adjusted to account for shares available for public trading.

3. Add the free-float values: The free-float market capitalisation of all 30 companies is added together.

4. Apply the index formula: The combined value is used in the index calculation, with the base market capitalisation and base index value helping determine the Sensex level. The index divisor also helps keep the index comparable when changes such as corporate actions take place.

In simple terms, the Sensex reflects changes in the combined free-float value of its constituent companies. If this value increases, the index generally rises. If it decreases, the index generally falls.

Why Does Free-Float Market Capitalisation Matter?

Free float market capitalization also has an impact on the influence which each company has on the Sensex. A large free float company will exert more influence on the index than a small free float company.

This is also the reason why a shift in the share price of a heavily weighted company can drive the Sensex by a larger percentage than a similarly weighted company.

The approach also prevents fully weighted shares that are not typically traded. Consequently, the index is a measure of the market value of the shares that investors can easily trade.

How Can Investors Use the Sensex?

The Sensex today serves as an indicator of the overall performance of the stock market, and investors use it to gauge the overall trend of the market. The Sensex could give an indication of whether the index is moving up or down from the previous closing price. But the index is not enough to account for the market’s movement. Share prices can be influenced by company performance, interest rates, world events and investor activity.

Though the Sensex is a handy market indicator it cannot be seen as a reflection of the performance of all the companies listed on the exchange. Stocks may react differently than the index, so investors should also research a company’s financial position and business performance and risks before investing.

Conclusion

The Sensex is based on the free-float market capitalisation of 30 major companies quoted on BSE. This approach takes into account the number of shares available in the market, and assigns varying weights to different companies depending on the value of their free-float shares. The calculation will help investors appreciate the market better, rather than just paying attention to the up or down of the index. If an investor is interested in investing, he can learn about the basics, compare the options and register the demat account with a registered broker before investing in shares.

Author Profile

Adam Regan: Deputy Editor

Features and account management. 7 years media experience. Previously covered features for online and print editions.

Email Adam@MarkMeets.com