What makes an index tick?

NEXT time you look at the performance of the Australian stockmarket, it might pay to look closely at how that performance is measured.

While the All Ordinaries Index, which covers the 500 largest stocks, is quoted most frequently, the reality is that movements in the Australian market can be driven by a handful of stocks.

Five companies account for one third of the total value of the Australian market. On many occasions, big moves in News Corp or Telstra have dictated the tone of the overall market because of their sheer scale.

The S&P/ASX 200, which has become a widely used measure of market health, covers 91 per cent of market value.

This index does not simply comprise the 200 largest companies on the ASX. To qualify for inclusion, a listed company also has to be liquid; that is, a large volume of trading must occur in that stock. Flight Centre is a prime example of a company that would qualify for inclusion based on its market capitalisation, but is excluded as liquidity is comparatively low (a large portion of the stock is held by staff and directors).

The All Ordinaries, by contrast, is based solely on market capitalisation and does not take account of liquidity. The 500 companies in this Index represent 99 per cent of total market value.

That leaves about 800 small companies that collectively account for just 1 per cent of total market value.

Another way of looking at the Australian market is to distinguish between industrial stocks and resources stocks. The All Resources Index, which is dominated by BHP and to a lesser extent Rio Tinto, WMC and Woodside, represents 14.6 per cent of total market value. That compares with 30 per cent in the mid ’90s (60 per cent in the mid ’80s).

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