Sensing the Sensex; Significance of Sensex Crossing 30000.

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So, the sensex crossed the 30,000 mark today, thus creating the history. But what does that mean for you and me? Why it breached 30,000 mark? Is it a good omen for the Indian economy? Shall the retail investor invest more, in the hope of more upswing?

In today’s blog I will try to address these issues. But before I start, I will explain few terms:

  1. Stocks: Besides the obvious reason of meeting their operational expenses, Companies need money for multiple reasons. They can raise the money commonly by either taking loans or issuing stocks. Stocks are a share of a company held by an individual or a group. Stockowners become the partial owner of the companies. Stocks are bought and sold on an exchange. BSE (Bombay Stock Exchange) and NSE (National Stock Exchange) are the two most popular stock exchanges of India.
  2. Sensex and Nifty: How does one measure the performance of the stock market? There has to be some scale or measurement index!! In fact there are many scales, Sensex and Nifty are the two most talked about scales of BSE and NSE respectively. Sensex comprises of top 30 companies, in terms of the market capitalization, of BSE. Market Capitalization of a company is the number of free floating stocks multiplied to the price of one share. The free float market cap is then divided by a base value known as the Index divisor to arrive at the value of the sensex.
  3. Free Float and Index Divisor: Free floating stocks are those stocks which are readily available for trading among the public. This excludes stock holdings of promoters, governments etc.

There has to be a base against which the scale has to be measured (Remember that any scale will have a starting point for example a zero, which will be used as point of reference). The value of the sensex which is used as the base is known as the index divisor. In India 1978-79 is the base year for the Sensex.

Nifty is also calculated similarly but it comprises of top 50 companies in the terms of market cap. Besides Sensex and Nifty there are several other scales or indexes.

Why is the Sensex most talked about index?

Simple. The index comprises of the 30 most precious companies. So, in a way it represents the health of the top 30 companies which many people assume to be an indicator of the entire economy.

Is Sensex a true representation of the Indian Economy?

No.  Economy of a country is dependent on many factors, stock markets being just one among those.  Sensex being one of the many indexes of BSE does not even reflect the true health of the stock market.  For example, it is quite possible that the Sensex has shown growth but the shares of the manufacturing companies have performed poorly.  So, can we say that market is performing well?

So, What does the Sensex of 30000 signifies?

It certainly does not signify that India as an economy is doing well. It only signifies that the market is bullish i.e. feeling good or hopeful about its future prospect. Sensex in addition to the report card of the past work is more a report card on the future prospect.   Sensex at historical level of course gives a reason to celebrate but with every celebration one has to administer caution.

Why has it reached the historic level?
 As explained, mainly because the investors and the market have turned hopeful.

  • Ever since Narendra Modi led BJP took charge of the country, the markets have been positive and hopeful because they expect investor and market friendly policies from the government.
  • The budget announced few days back had a slew of measures and suggestions that further strengthens the hope that government intends to create an investor friendly climate (Refer: points on GAAR, MAT and corporate tax in my previous blog)
  • The final push came when RBI slashed the repo rate by .25%. The reduction in repo rate will reduce the cost of borrowing for the corporates. (More on repo rate in my next blog on finance next week)

Is the market overvalued? Will Sensex grow further?

That is the question, perhaps that is the fuel which keeps market working. Nobody knows the actual value of the Sensex at any given time. And since nobody knows the true level it becomes extremely difficult to take a stand on the future prospects.

Theoretically, it is possible to find out the true value of an asset (Sensex is an asset). Theoretically, it is impossible for anyone or for the few people to earn super normal profits in the market. But the theories discount the fact that the human beings are irrational, greedy and judgemental.  And that is why there will always be difference between the ideal theoretical value and the actual market value of an asset.  Very often those who have more information or those who have the intelligence to process the information or those who have the ability to show restrain earn more in the market.

What should a retail investor do?

He shall certainly not invest indiscriminately. The best way to realise returns from the Stock Market is to invest through SIPs (Systematic Investment Plan). SIP allows you to invest a certain pre-determined amount at a regular interval (weekly, monthly, quarterly, etc.) thus reducing the risk factor due to the volatility of the stock market.

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