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Why some stocks are more influential
We often hear news that the Sensex rose 200 points led by a one stock or the other stock. Many a times, a similar gain in two stocks affects an index in different ways. This means, some stocks are more influential than others.
Here are pointers that explain the difference:
This is the total market value of a company’s shares, calculated by multiplying the share price with the total number of shares issued. As a result, the market capitalisation for a stock changes every day in tune with the stock price fluctuations. For example, if a company has listed 10,000 shares, which are traded at Rs 100 apiece, the market capitalisation is Rs 10,00,000.
Free-float market capitalisation:
When a company issues shares, only a portion is available to the public for actual trading. The rest is held by promoters or the government, or are locked from trading. So, total market capitalisation does not reflect the real market value available to the public. For this purpose, the free-float market capitalisation method is used, where the share price is multiplied by the total shares available to the public. For this reason, it is smaller than the market capitalisation. It also changes along with the stock’s price.
Indices are formed on the basis of the free-float market capitalisation of companies in the exchange. Companies with the largest free-float m-cap are part of benchmark indices like the BSE Sensex or NSE Nifty. In such a case, the value of the index is closely tied to the free-float market capitalisation of the constituents.
Not all companies have the same share price or free-float market cap on an index. It could happen that a stock with a larger market cap will have a lower price, or vice versa. In such cases, their overall impact on the index value is skewed. To smoothen this, each stock is given a particular weightage depending on their free-float m-caps. Companies with a large weightage are called market heavy-weights. Any increase or decrease in their share prices has a greater impact on the change in the index value.
The weightage of a company is calculated by dividing the free-float market cap by the total market capitalisation of the index and then multiplied by 100. For example, if there are two stocks on an index with total market value of Rs 100 crore, and the m-caps of the two stocks are Rs 15 crore and Rs 85 crore respectively, the first stock will have a weightage of 15%, will the other will have a weightage of 85%. This means, higher the total free-float m-cap, greater will be the weightage. Weightage changes with drastic increase or decrease in the stock price as well as the total shares available to the public.
Going by the previous example, suppose the index value today is 10,000. The first stock accounts for 15% of the index value of 10,000, i.e., 1500. Similarly, the other stock’s value is 8500. Now suppose the first stock’s price rises by 10%, its value as a portion of the index rises to 1650. As a result, the index value increases by 150 points to 10,000. This is just a 1.5% rise. In contrast, a 10% rise in the other stock’s value of 8500 to 9350, will increase the index value by 850 or 8.5%.
Consumer goods major ITC is the most influential stock on the Nifty with a 7.27% weightage, as of June 9, 2014. Its share price was Rs 338. Coming at a close second is Reliance Industries with a weightage of 7.17% and a share price of Rs 1125.