Anyone living in India, no matter whether he or she is active in the stock market or not, would have definitely heard about Nifty 50 at some point in time. National Stock Exchange Fifty or Nifty 50 is the benchmark Index of India constitute top 50 companies of India and tells a lot about its economy. It is one among the many Index formulated by the National Stock Exchange (NSE) of India but it represents 66% of the total float-adjusted market capital of NSE (Float adjusted market capital for a company is calculated by multiplying share value with numbers of share which can be traded). We are always concerned with the numerical value of Nifty 50 represents but never tried to decode it that how NSE came up with that number. Let us find out how it is done?
There are around 1600 companies listed on National stock exchange (NSE) in which 1328 are active. Out of these 1328, NSE chooses top 500 companies according to their free-float market capitalisation to formulate various Indexes like Nifty100, Nifty50, Nifty Next50, Nifty small-cap, Nifty large-cap etc. These are broad market index as these indexes include companies from all the sector. There are a total of 13 broad market indexes. (Shown Below)
Out of the 500 companies, top 100 companies form Nifty 100 and out of these 100 companies, top 50 companies form NIFTY 50 and other 50 companies form NiftyNext50.
Okay, now we have some idea that how these companies are selected for Index formation. We will now dive into the calculation part that how a particular numerical value, like 10500 for NIFTY50, comes out. Here we will focus on how nifty 50 is calculated. All the other indexes in NSE are formulated in similar ways with little tweaks (Except Strategy Index). I'll be mentioning about them side by side so we can get the rough idea about them.
Nifty 50 Computation
Market Capitalization
For understanding the nifty formulation first we have to learn about the market capitalization or just market cap of a company. Total Market Capitalization of a company is the total value of the company in monetary terms. It is calculated by multiplying the total numbers of shares issued by the company by the value of a share.
Total Market Capitalization = Total number of shares*Share Price
When we calculate the total market cap we include all the share issued by the company. Among these shares, there are many shares which are not traded on the Index as these shares are held by promoters or government and are not publicly available. Total market capitalisation does not represent the public sentiment that much accurately. So we use free-float market capitalization to calculate the genuine public value of a company. When we calculate free-float market capitalization we exclude all those shares which are not available for trading.
Free Float Market Capitalization = (Total Number share - Shares that cant be traded)* Share price
Below is the list of shares which are treated as Non-Publicly Tradeable by NSE -
Shareholding of promoter and promoter group
Government holding in the capacity of the strategic investor
Shares held by promoters through ADR/GDRs.
Strategic stakes by corporate bodies (to the extent identifiable)
Investments under FDI category
Equity held by associate/group companies (cross-holdings)
Employee Welfare Trusts
Shares under lock-in category
Given is the example of how free-float market capitalization is calculated -
Let an XYZ Company has a total number of shares = 1,00,00,000
Shareholding of promoter and promoter group = 19,75,000
Government holding in the capacity of the strategic investor = 50,000
Shares held by promoters through ADR/GDRs. = 2,50,000
Equity held by associate/group companies (cross-holdings) = 12,575
Employee Welfare Trusts = 1,45,987
Shares under lock-in category = 14,78,500
Total = 39,12,062
Share Price = Rs. 20
Market Cap = 1,00,00,000 * 20 = Rs. 20,00,00,000
Free Float Market Cap = (1,00,00,00 - 39,12,062) * 20 = Rs. 12,17,58,760
Base Date and Base Value
The second thing we have to understand is the Base date of the Index. This can be said as the first day of the index or the day from which we are comparing the current value. This is on NSE to select any base year and base value. For NIFTY 50 base date is 03 November 1995 and Base value is 1000. Base Date and Base value is different for each Index (Mentioned Below).
Index Formula
After getting the base value of the index and the free float capitalisation of the constituent companies we can calculate the present value of the index by the given formula -
Many indexes around the world are based on free-float market capitalisation method like the S&P 500, MSCI World Index, Topix etc. This method comes with its own flaws mainly the issue of momentum tilt i.e the index will be more tilted towards the company with high free-float market capitalization and the effect of those companies on the index is huge. Like in NIFTY 50 companies like Reliance and HDFC have high free-float market value. So they have high weightage (Given Below) in the index and can dictate the direction of the index by themselves. We should keep in mind while we looking at the Index for investing purpose.
There are many other indexes that NSE formulate which can be specific to either sector like Nifty auto, Nifty finance, Nifty IT etc. or to a strategy like Nifty Alpha, Nifty Beta, Nifty Growth and many more. You can learn more about them by visiting the NSE Website.