Family of NEPSE indices and their significance; NEPSE index is not the only important index that you should be watching

We daily follow the market and one of the things that catches our eye first in the NEPSE index. The NEPSE index is the composite value of all securities listed in Nepal Stock Exchange (NEPSE).

However apart from the NEPSE index itself, there are other indices in the NEPSE index family that provide valuable information to the investors.

These indices are:

1. NEPSE index
2. Sensitive index
3. Float index
4. Float sensitive index
5. Sub-indices

Each of index listed above are calculated on the basis of value weighted method. So, index = (Market capitalization of all shares/Base market capitalization)*100. The base market capitalization is different for each index based the date of commencement.

The above listed indices are discussed briefly below:

NEPSE index:

NEPSE index is the head of Nepal Stock Exchange's index family. The history of NEPSE index goes back to the establishment of NEPSE itself i.e. on February 12th, 1994.

The NEPSE index takes the market price of all the listed shares and the changes in their prices is reflected in the index. Mathematically,

NEPSE index = (Total market capitalization/Base market capitalization)*100

However, a serious disease looms the index calculation technique. While calculating the total market capitalization the number of total listed shares is multiplied with the current market price and this paints an inaccurate figure because the total listed shares include the promoter shares too and the price that is used as a multiplier is the price of the ordinary share.

For example; the market price of Nepal Telecom (NTC) is Rs 703 today and therefore the market capitalization of NTC will be total shares listed multiplied by Rs 703. However, approximately 91% of NTC's shares are of promoter category (owned by government) which is not being traded in the market and therefore won't be prices at Rs 703. Now, you can see if the figure that we get is a realistic one.

As of June 27, 2019 the total market capitalization was Rs 1,564,430.79 million whereas the Float Market Capitalization stood at Rs. 548,355.89 million, which is only 35% of the total market capitalization. Thus the index that we are seeing, may not sufficiently portray the market behavior.

Sensitive Index:

The sensitive index was introduced by NEPSE from January 01, 2007 and that date marks the base market capitalization. Unlike NEPSE index, the sensitive index considers only selected companies. These companies are taken if they fulfill the following criteria:

1. Minimum paid-up capital of Rs 2 crore
2. More than 1000 ordinary shareholders
3. At least three consecutive years of profitability
4. Book value of share higher than its par values
5. Publication of annual report within 6 months of completion of the fiscal year

Thus the companies fulfilling these criteria will be considered while calculating the sensitive index. The sensitive index is particularly important because it shows the movement in high performing stocks of the market.

Float index:

Float, in stock market, refers to the number of shares that are being actively traded. The investors need to know the float status of a stock market because it shows the actual supply of any share in the market.

In case of Nepal, all the companies have promoter as well as public shares and both of them are listed in NEPSE. However, despite being listed the promoter shares are rarely traded with some exceptions. Even in case of public/ordinary shares, most investors tend to hold the shares for a longer term and that declines the float of share market.

The NEPSE hasn't identified mechanism to determine the float in public shares yet, therefore the float index takes the ordinary shares of all listed companies to determine its index value. NEPSE had introduced the float index on September 15, 2008 and that is the base market capitalization date for this index.

Float sensitive index:

The float sensitive index was introduced on September 15, 2008, same date as the float index. The float sensitive index takes into account the public/ordinary shares of companies that are eligible for the sensitive index.

In many of the large companies that are on the sensitive index lists, the promoter: public ownership ratio is heavier towards the promoter side. So, the infrequent trading of promoter shares stabilizes the index more than what is truly happening in the ordinary shares' prices.

Thus the float sensitive index considers only the ordinary shares of high performing stocks and helps investors see where the larger companies are heading toward.

PROBLEM

The problem with sensitive, float and float sensitive index is associated with their base date capitalization. The base date for sensitive index is 2007 and for float and float sensitive index is 2008 and at this point the reader must note that this the period where our market was flourishing and was moving towards a bull.

As you see the NEPSE website for latest report, the sensitive stands at 271.16 points, float stands at 92.25 points and float sensitive stands at 85.97 points. Since sensitive was a year earlier it is above the base of 100 points but what about the float and float sensitive index. Both of these indices are below 100 points and please look at your portfolio, has it done down that badly?

The 92.25 points of float index indicates that the price of ordinary shares has gone below the par, but if we see all the listed companies there are barely a dozen companies whose price is below Rs 100. The point is, when we see an index, any index, we want to see the changes in market for the last 25 years and not just the last 11 years.

Sub-indices:

The sub-indices provide the information regarding each sector that is identified by NEPSE. The stock market is an information-sensitive market and not all information impact all the companies in the same way. For example, the outcome of monetary policy has a huge impact on the share price changes of banks and financial institutions (BFIs), but at the same time it may not have any impact on manufacturing companies such as Bottler's Nepal.

Thus, the sub-index of each sector shows the investor how the market is responding towards the information disseminated. In addition to that the history has shown that in every bull and bear, there are some distinct sector that pulls or pushes the market and the sub-index can play a major role in identifying which sector is it.

The various sub-indices that NEPSE has are:

1. Commercial banks
2. Development banks
3. Finance
4. Life Insurance
5. Non-life insurance
6. Microfinance
7. Mutual fund
8. Manufacturing & processing
9. Others
10. Hotels
11. Hydropower

One major flaw with the sub-indices of NEPSE is the way they were broken down. Prior to 2018, both the life insurance and non-life insurance companies were counted under one heading as Insurance. But in July 16, 2018 the insurance was broken down into life insurance and non-life insurance sector. On that day the insurance sub-index stood at 6,199.45 points and the problem is on the next day both life insurance and non-life insurance sub index started from 6,199.45 points, which as we see is far from realistic.

The index distribution should have been different for reasons such as number of companies under each sector and the respective market capitalization, which could have altered the weight each sector contributed the Insurance heading. So, it is for NEPSE to answer was there a technical reason or the analysts didn't feel like putting in the extra hours?

Playing the blame game is lame and we wouldn't be doing it if it was a singular case. But the same happened when the Microfinance sub-index was created by breaking the Development bank index. The development bank's sub-index stood at 1,832.52 on November 01, 2017 and on the same date the Microfinance sector was segregated out of it. Then, on the opening date, the Microfinance's sub-index stood at 1,832.52 points. So, what does that say about our index?

Conclusion

All the available indices, at their core, are very relevant and useful for investors. However, the way they are calculated in Nepal stock market (NEPSE) is not entirely reliance. It is high-time for NEPSE to step up its game.

In large stock exchanges around the world, indices are calculated on the basis of few selected representative stocks and it might be time us to do something similar. The S&P 500 takes the market capitalization of 500 selected companies that represents all the sector of the economy. Likewise the BSE SENSEX is a free-float market-weighted stock market index of 30 well-established and financially sound companies listed on Bombay Stock Exchange. The Nifty Fifty index of National Stock Exchange (NSE) of India takes 50 constituent companies.

NEPSE can also take few large banks, leading hydropower such as Chilime Hydropower Company, and others such as Nepal Telecom and so on based on research to create a more composite and comprehensive index value that best depicts the market behavior and thereby will aid the investors in doing proper analysis and sound decision making.