Did you know: How is Nifty50 computed? How are stocks included/excluded from the list?

The National Stock Exchange’s (NSE) benchmark index, Nifty 50, is set to witness some changes effective September 29, 2017.

ACC, Bank of Baroda, Tata Power and Tata Motors DVR will move out from the NSE’s benchmark Nifty 50 index. These firms would be replaced by Bajaj Finance, Hindustan Petroleum Corporation and UPL.

The changes were announced by India Index Services and Products (IISL), an arm of the National Stock Exchange (NSE), as part of its periodic review.

Besides Nifty 50, IISL has also decided the replacement of stock on various other indices including Nifty Next 50, Nifty 500, Nifty 100, Nifty Midcap 150, Nifty Smallcap 250, Nifty Midcap 50, Nifty 200, Nifty Smallcap 50 as well as sectoral indices like Nifty IT, Nifty Realty and Nifty PSU Banks.

The changes come in the backdrop of India Index Services and Products (IISL), a group firm of NSE, revising guidelines to rejig their indices, including the selection criteria.

So, how does this whole system of rejigging the Nifty index work? Moneycontrol tries to explain the process behind this.

What is the Nifty?

It is a diversified 50 stock index accounting for 12 sectors of the economy. This is owned and managed by India Index Services and Products. (IISL). IISL is India's specialised company focused upon the index as a core product.

How is the Nifty computed?

According to the NSE’s website, the index is computed using free float market capitalization weighted method. Under this, the level of the index reflects the total market value of all the stocks in the index relative to a particular base period. The period in this case is the close of prices on November 3, 1995, which marks the completion of one year of operations of NSE's Capital Market Segment.

It must be noted that the method also considers constituent changes in the index and corporate actions such as stock splits, rights, etc without affecting the index value.

What is the criteria for selection of stocks?

Usually, it is based on the liquidity and other factors such as out of IPO period, replacement, among others.

NSE explains that… “For inclusion in the index, the security should have traded at an average impact cost of 0.50 percent or less during the last six months for 90 percent of the observations for a basket size of Rs 2 crore.”

Other factors:

1. A stock could come under consideration once it has come out of an IPO, if it fulfils the parameters such as impact cost, market capitalisation and floating stock, for a 3- month period than 6-month period.

2. Availability for trading in the derivatives segment.

3. Replacement of stock

- Developments such as corporate actions, delisting, among others, could lead to a replacement of the stock. In this case, the stock with the largest free float market cap and satisfying other requirement related to liquidity, turnover and free float will be considered for inclusion, the portal added.

- When a better candidate is available in the replacement pool, which can replace the index stock i.e. the stock with the highest free float market capitalization in the replacement pool has at least twice the free float market capitalization of the index stock with the lowest free float market capitalization.

Does it mean bad news for the stock to be excluded?

Not necessarily. It could be a case where the parameters are changed for inclusion/exclusion in the Nifty and the stock could have performed steady. Having said that, in the news development from Monday, these companies were underperformers.

Can companies make a comeback on the index?

Yes. They can. If there is a sustained healthy performance in the stock along with increasing market capitalisation, then such stocks can make a comeback, subject to fulfilment of other criterion mentioned above.