What is an Index Divisor?

The stock indices reflect the performance of the stock market. Therefore, they are popularly known as the barometer of the stock market. The value of stock indices is determined based on some values. index divisor is one of the factors that help in determining it.

Investors who understand index divisors tend to monitor and analyze the performance of the stock market more effectively.

Index Divisor

An Index Divisor is a number by which the total value of an index is divided to arrive at the initial market index. The Index Divisor does not change frequently, and it also helps in arriving at the intended easy value of the market index. The Index Divisor is significant as the total value of the index will be a large number.

For example, if the total value of the constituents of the index is 986. To set a market index at an easy number like 100, the total value of the index can be divided by a divisor of 9.86. This divisor remains constant over time, except in the case of significant material changes. Stock market changes are reflected in the value of the market index.

If the total value of the index changes, the divisor will be used with a new number. Therefore, the new value of the market index will arrive. Index Divisor is used to secure the index from significant alterations due to special dividends,stock splits, spin-offs, etc.

Types of stock indexes

Mainly, there are two types of stock indices: the Price-weighted index, and the Market-cap-weighted index.

A price-weighted index can be calculated by dividing the sum of all the constituents of the index, by Index Divisor. This index is highly impacted by higher share price companies. Japan’s Nikkei 225 and US Dow Jones Industrial Average are price-weighted indexes.

A market-cap-weighted index is based on market capitalization. Market capitalization is determined by multiplying the outstanding shares of a company by its current market price. In this index, the constituents are weighted according to their relative market cap. The NASDAQ Composite Index and S&P 500 index are market-cap-weighted indexes.

Example of Index Divisor

To understand the divisor, let us calculate the Index Divisor of BSE. Sensex is a market-cap-weighted index. If the market cap of 30 components of Sensex is 9450000 and the base index of 1978-79 is 60000. Then, the Index Divisor will be 100/60000. The Sensex value for the day will be 9450000*100/60000 = 15750.

Thus, the Index Divisor plays a dominant role in determining the index. The stock index value tends to change frequently and significantly in the absence of a standardized divisor. It makes the task of tracking indices easier for investors.