What’s a stock index number and how to compute it

Information technology companies now command a lot of attention, both in the West and in India. Quite obviously, 30 years ago, this would not have been the case. An index ought to be broad-based and represent a significant cross-section of the market that it is trying to mirror.

The Dow is based on 30 stocks and is price-weighted. A price-weighted index is computed by adding up the latest prices of all the component stocks and dividing the price aggregate by a number known as the ‘divisor’.

On the ‘base date’, which is the day on which the index is being computed for the first time, the divisor can be any arbitrary value. A logical value would be the number of companies being included in the index.

Subsequently, the divisor may have to be amended for any of the following reasons. The first is that there could be a corporate action such as, a stock split or a reverse split, a stock dividend or a bonus issue, or a rights issue at a discount to the prevailing market price. Second, there may be a change in the composition of the index in the sense that one constituent company may be replaced with another.

The impact of such changes could be

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