SENSEX Market....Stock Indices..@

WHAT ARE STOCK INDICES?

From among the stocks listed on the exchange, some similar stocks are selected and grouped together to form an index. This classification may be on the basis of the industry the companies belong to, the size of the company, market capitalization or some other basis. For example, the BSE Sensex is an index consisting of 30 stocks. Similarly, the BSE 500 is an index consisting of 500 stocks.

The values of the grouped stocks are used to calculate the value of the index. Any change in the price of the stocks leads to a change in the index value. An index is thus indicative of the changes in the market.

Some of the important indices in India are:

• Benchmark indices – BSE Sensex and NSE Nifty
• Sectoral indices like BSE Bankex and CNX IT
• Market capitalization-based indices like the BSE Smallcap and BSE Midcap
• Broad-market indices like BSE 100 and BSE 500

   

WHY DO WE NEED INDICES?

Indices are an important part of the stock market. Here’s why we need stock indices:

Sorting:

In a share market, there are thousands of companies listed. How do you differentiate between all of those and pick one or two to buy? How do you sort them out? It is a classic case of a pin in a stack of hay. This is where indices come into the picture. Companies and their shares are classified into indices based on key characteristics like size of company, sector or industry they belong to, and so on.

Representation

Indices act as a representative of the entire market or a certain segment of the market. In India, the BSE Sensex and the NSE Nifty are considered the benchmark indices. They are considered to represent the overall market performance. Similarly, an index formed of IT stocks is supposed to represent all stocks of companies from the industry.

Comparison

An index makes it easy for an investor to compare performance. An index can be used as a benchmark to compare against. For example, in India the Sensex is often used as a benchmark. So, to find if a stock has outperformed the market, you simply compare the price trends of the index and the stock. On the other hand, an index can also be used to compare a set of stocks against a benchmark or another index. For example, on a given day, the benchmark index like Sensex may jump 200 points, but this rally may not extend to a certain segment of stocks like IT. Then, the fall in the value of index representing IT stocks could be used for comparison rather than each individual stocks. This also helps investors identify market trends easily.

Reflection

Investor sentiment is a very important aspect of stock market movements. This is because, if sentiment is positive, there will be demand for a stock. This will subsequently lead to a rise in prices. It is very difficult to gauge investor sentiment correctly. Indices help reflect investor’s mood – not just for the overall market, but even sector-wise and across company sizes. You can simply compare an index with a benchmark to see if has underperformed or outperformed. This will, in turn, reflect investor sentiment.

Passive investment

Many investors prefer to invest in a portfolio of securities that closely resembles an index. This is called passive investment. An index portfolio helps investors cut down cost of research and stock selection. They rely on the index for stock selection. As a result, portfolio returns will match that of the index. For example, if Sensex gave 8% returns in one month, an investor’s portfolio that resembles the Sensex is also likely to give the same amount of returns. Indices are also used to construct mutual funds and exchange-traded funds (ETFs).

HOW ARE STOCK INDICES FORMED?

An index consists of similar stocks. This could be on the basis of industry, company size, market capitalization or another parameter. Once the stocks are selected, the index value is calculated. This could be a simple average of the prices of the components. In India, the free-float market capitalization is commonly used instead of prices to calculate the value of an index.

The two most common kinds of indices are – Price-weighted and market capitalization-weighted index.

What is stock weightage?

Every stock has a different price. So, a 1% change in one stock may not equal a similar change in another stock’s price. So, the index value cannot be a simple total of the prices of all the stocks. Here is where the concept of stock weightage comes into play. Each stock in an index has a particular weightage depending on its price or market capitalization. This is the amount of impact a change in the stock’s price has on index value.

• Market-cap weightage
  Market capitalization is the total market value of a company’s stock. This is calculated by multiplying the share price of a stock with the total number of stocks floated by the company. It thus takes into consideration both the size and the price of the stock. In an index using market-cap weightage, stocks are given weightage on the basis of their market capitalization in comparison with the total market-capitalization of the index. For example, if stock A has a market capitalization of Rs. 10,000 while the index it is part of has a total m-cap of Rs. 1,00,000, then its weightage will be 10%. Similarly, another stock with a market-cap of Rs. 50,000, will have a weightage of 50%.
  The point to remember is that market capitalization changes every day as the stock price fluctuates. For this reason, a stock’s weightage too changes every day. However, it is usually a marginal change. Also, the market capitalization-weightage method gives more importance to companies with higher m-caps.
  In India, most indices use free-float market capitalization. In this method, instead of using the total shares listed by a company to calculate market capitalization, only the amount of shares publicly available for trading are used. As a result, free-float market capitalization is a smaller figure than market capitalization.
• Price weightage
  In this method, an index value is calculated on the basis of the company’s stock price, and not market capitalization. Stocks with higher prices have greater weightages in the index than stocks with lower prices. The Dow Jones Industrial Average in the US and the Nikkei 225 in Japan are examples of price-weighted indices.
  There are also other kinds of weightages like equal-value weightage or fundamental weightage. However, they are rarely used by public indices.

HOW IS INDEX VALUE CALCULATED?

An index’s value depends on whether it is a price-weighted index or market cap-weighted. Let us take the example of the BSE Sensex to understand how an index is calculated.

WHAT ARE COMPANY EARNINGS?

         

     Companies undertake activities that produce a good or service. This is sold to customers who pay a certain amount of money for it. The total amount the company receives is called 'revenue'. A company also incurs expenses on employees, utility bills, costs of production and other operating expenses.

Once you deduct these expenses, the surplus left is the company’s earnings, or net profit. Usually, income earned from operations is the key source of profits. Many companies also earn additional income from different kinds of investments.
Investments generate income for businesses by way of either interest on loans, dividends from other businesses, or gains on the sale of investment property.

Thus, company earnings are the sum of income from sales or investment left after the company has met its obligations.

WHAT ARE QUARTERLY AND OTHER FINANCIAL REPORTS?

Every three months, every company has to submit details about its financial performance. These are called quarterly reports. In addition, companies may also provide with special reports called statistical supplements. These provide investors with additional financial information. These, however, are not as comprehensive as the annual report.

Thus, quarterly reports are very similar to the annual reports, except they are issued every three months and are less comprehensive. These are filed with the stock exchange, which then makes it available to investors.

WHY ARE EARNINGS IMPORTANT TO YOU AS AN INVESTOR?

As an investor who holds shares of the company, you have part ownership of the company. You are thus entitled to get a portion of the company's profit as dividends. Until you sell the stock, this is your primary source of income as an investor from the stock holding. As a result, if the company does well and earns more profit, you receive more as dividend. Not just that, it will also drive up the inherent value of your shareholding. This means you earn more returns.

Sometimes, when a company is in the initial stages of growth, it may choose to reinvest its earnings for operations and expansion. While you are temporarily at a loss as an investor, this increases the likelihood that you will get higher dividends in the future.
Company earnings are important to you, even if you hold its bonds. This is because, when you lend money to the company by investing in its bonds, the company uses part of its earnings to repay you through interest payments. The greater the company’s earnings, the more secure you can be that you will receive your interest payments. So, company earnings are important to you because you make money when the business you invest in makes money.

INSIDE THE ANNUAL REPORT:

Here is what comprises an annual report:

•                                                                                                                                                          ..... WaiT SomE timE