8. What are Market Indices?

You must have heard in the news that the “Pakistan stock market went down by 100 points on Thursday.” What does this statement mean? Well, the points here refer to the value of an Index.

An Index is a tool to measure change in a representative group. Let’s suppose you want to measure the change in cost of living in Pakistan. In 2014, it cost a Pakistani family of four Rs. 50,000 to afford housing, clothing and other basic amenities. To make it simple and to standardize it, you decide to make a Cost of Living index in 2014 and give it a value of 100. In 2018, it costs a Pakistani family of four Rs. 70,000 to afford basic necessities. This is an increase of 40%. However, it’s much simpler to state this change in Index terms. You can say that the Cost of Living Index increased from 100 in Year 2014 to 140 in Year 2018 – an increase of 40%. Just like a Cost of Living index, a Stock Market Index is a standard measure to reflect the performance of the overall market or a particular sector over a period of time.

Two key questions pertaining to Market Indices are:

  1. How to measure the worth of any index?
  2. Which stocks should be included in a particular index? 

To answer the first question, there are two basic methods to calculate the value of an index.

8.1. Price-Weighted Index

Suppose there are 5 public companies manufacturing fertilizers in Pakistan. The stock prices of these four companies on 31st October, 2017 were as follows:

  • Company W = Rs. 10
  • Company X = Rs. 15
  • Company Y = Rs. 20
  • Company Z = Rs. 25

The total price of the four companies comes out to be Rs. 70. We set 2017 as our base year and value of Fertilizer index as 100. This is to standardize the index value in the base year so that it’s easy to measure performance against it in future periods. Now consider the following prices on 31st October, 2018:

  • Company W = Rs. 20
  • Company X = Rs. 10
  • Company Y = Rs. 25
  • Company Z = Rs. 30

The total price is Rs. 85. Comparing it to the total price of the same companies last year, this is an increase of approximately 21.4%. In index terms, the Fertilizer index increased from 100 in 2017 to 121.42 in 2018 or that the Index increased by 21.4 points.

8.2. Value-Weighted Index

Value-weighted Index is similar to Price-Weighted Index except that we use market capitalization of stocks rather than share prices. The stock prices, shares outstanding and market capitalization of two companies on 31st October, 2017 and 31st October, 2018 are given below:

Company X

 

2017

2018

Change

Price per Share

Rs. 10

Rs. 12

 

Outstanding Shares

1000 Shares

1000 Shares

 

Market Capitalization

Rs. 10,000

Rs. 12,000

20%

Company Y

 

2017

2018

Change

Price per Share

Rs. 9

Rs. 10

 

Outstanding Shares

2,000 Shares

2,000 Shares

 

Market Capitalization

Rs. 18,000

Rs. 20,000

11%

Total

Rs. 28,000

Rs. 32,000

14%

Suppose the base year was 2017 and the Index value was 1000. In 2018, the index increased by 14% to 1140. In other words, the index increased by 140 points.

8.3. Composition of Indices

There are five major market indices in the Pakistan Stock Market. These indices are KSE 100 Index, KSE All Shares Index, KSE 30 Index, KMI 30 Index and PSX – KMI All Shares Index. Each index has a complex set of rules to determine which stocks would be included or excluded from an index.

There is another type of Index called “Tradable Index.” Suppose an investor doesn’t want to spend time researching on every Fertilizer stock listed on the PSX. However, he is sure that the entire sector is going to perform well owing to the current macroeconomic situation and favorable government policies. Such an investor can simply buy a Fertilizer Index which is representative of almost all listed Fertilizer stocks. However, in reality, there is no tradable Fertilizer Index in Pakistan. Following are the only two tradable indices in the Pakistan Stock Market:

  • BKTi: This is the index representing performance of the Banking sector in Pakistan. It constitutes major banks such as Bank Al Habib, Bank Alfalah, Bank of Punjab, Habib Bank, MCB Bank, United Bank and National Bank.
  • OGTi: The second tradable index represents the overall performance of Oil & Gas companies in Pakistan. It includes Oil & Gas Development Corporation, Pakistan Petroleum Limited and Pakistan Oilfields Limited.

You can easily track the performance of market indices and tradable indices of PSX through FinPocket mobile application.