The NSE 20 share index has once again been overhauled with the inclusion of Safaricom to replace TPS Serena which was negatively affected by the post election violence. The inclusion of Safaricom was also done to make the index balance since after listing, Safaricom accounts for three quarters of NSE capitalization. Contrary to regulations governing the NSE 20 Share that requires a company to have been trading for a minimum of one year prior to its inclusion, an exception was given to Safaricom after considering the effect is has on the market capitalization, turnover and the liquidity. Additional conditions that a company needs to fulfill before it’s included in the index are having a minimum market capitalization of Ksh.50 million and 20% of its shares available for trading (this mean that Safaricom break two of these rules since only 15% of it is available for trading)
Other counters that have joined the NSE 20 Share index are Equity Bank, replacing Diamond Trust Bank in the finance and investment sector, East African Cables, replacing Sameer Africa and Athi River Mining, replacing Total Kenya in the industrial and allied sector.
The NSE 20 Share index measures the average performance of 20 large cap stocks drawn from different industries. However, experience indicates that most large cap stocks do not record a high performance as compared to low cap stocks. At times small cap counters record growth averaging at 50%, while this is unlikely for large cap stocks. This makes the 20 Share index to be biased towards a large cap counters and thus fails to transmit the right signals on the entire market performance to potential investors.
Similarly, the AIG 27 index dropped four counters from its index. The index dropped National Bank of Kenya, CFC Bank, East African Portland and Total Kenya counters and replaced them with Safaricom, Equity Bank, Kenya Re and Kenol.
Earlier in February this year, a new NSE All-Share index (Nasi) was introduced to complimentary to the NSE 20 share index. This was part of some of the recommendations by the International Finance Corporation (IFC) and regulators of world stock markets to ensure a comprehensive dissemination of market information to investors. unlike the 20 Share Index, which measures price movement in selected, relatively stable and best performing 20 listed companies, Nasi incorporates all listed companies irrespective of their performance and their time of listing. Nasi is calculated based on market capitalization, meaning that it reflects the total value of all listed companies at the NSE.
What exactly is an index and how important is it?
With two measures of market index at the NSE, many investors are usually left confused as to what exactly is a market index. In a simple language a stock market index is a measure of changes in the stocks markets and is usually considered to be reasonably representative of the market as a whole. Indexes are usually tabulated on a daily basis and involves summarizing sample shares price movements (NSE 20 share index) or all the share prices movements (Nasi)
To understanding the stock market index, it should not be read in its absolute numerical value but at the percentage change in its numerical value. One cannot invest in an index directly, but you can invest in index related stocks or mutual funds. The ups and downs of the index reflects the future expectation about of the market and its affected by many things including: news about performance of listed firms or the general country’s economic performance, changing interest in the market and changing profitability levels of the listed companies which affect dividend payouts.
As much as indexes give general information of the market, it will be futile for an investor to base his decision fully on it. The constant changing of the companies included in the index makes it hard to compare the indexes over the years. Indexes are usually weighted by size of the companies included; thus disproportion representation goes to large or giant companies. If one of them has a bad day, it can affect the whole index making it biased.
An investor should stay focused on the specific stocks and evaluate them rather than trying to keep pace with the market index, which only give the historical value of the market. Even on days when the NSE indexes are down there usually are stocks that performed well and the indexes may continue falling even when some stocks continue performing better. Focusing on the index is simply a waste of valuable time that could be used to analyze a company you want to invest in.