In simple words, Sensex is an index.
Index is a system which is prepared so that understanding and finding information is easy. In books an index usually consists of words with page numbers. This should help people find relevant information with ease.
Similarly the idea of an index or sometimes also called indice is to inform individuals on the performance of stock market. Sensex is the index used to determine the overall performance of the Bombay Stock Exchange. This index consists of 30 companies which represent the broad market covering different sectors.
There are nearly 5,000 companies listed on the BSE. One cannot look at all of their performance to decide how the share market is performing. This is where Sensex and all other indices come to our help. We can look at the Sensex which is the major and the oldest index on the BSE and determine the overall performance of the companies listed on the exchange.
How are the Sensex companies chosen?
It all starts with the first step, only companies which are listed on the Bombay stock exchange are eligible. Then companies should have listing history of over three months.
It is also important that the companies should have been traded on each and every trading day of the last three months. This shows the stocks are highly liquid, easily tradable.
They should not be holding companies and all companies which could compete for a position on the Sensex must report the revenue of their last 4 quarters.
And these companies revenues should come from their 'core activity", meaning the revenue should come from their main business. A simple example would be ACC, the company claims it is Cement manufacturer. Therefore, majority of its revenue should come from its cement business.
If the companies which fulfil the above criteria, the top 75 companies based on free-float market capitalisation (average 3 months) are selected as well as any additional companies that are in the top 75 based on full market capitalization (average 3 months). The three month average is taken to remove any anomaly which is possible on a single day.
The list of companies that emerge after running all the technical criteria are put to test on some of the subjective criteria like, selected companies should be big enough to represent its industry. Then another criterion states “In the opinion of the BSE Index Committee, all companies included within the SENSEX should have an acceptable track record." The BSE Index committee consists of experts from different fields of the financial world -- bankers, members of the capital market, business consultants and financial journalist.
At the end, the 30 companies which pass all the criteria mentioned above are part of the Sensex.