Friday, June 10, 2011

Investing in Philippine Stocks, Part 2: The PSEi


Dear Investor Juan (naks),

If I wanted to emulate the PSE index performance how would I do it?

A.  Buy equal numbers of shares of listed companies. or
B.  Buy equal peso values of shares of listed companies. or
C.  Something else.


Dear JP,

Seven years ago, when I was taking my first finance course in the UP MBA program, the first question I asked my professor was, "What is the Phisix?" (at that time the PSEi was still called "Phisix" or "PSE Composite index"; it was not until 2006 that the PSE's main index was named "PSEi"). The PSEi is the "face" of the stock market; it's what the media quotes whenever it reports goings on in the exchange or the state of the economy. Unfortunately, many of us do not sufficiently understand what it is. So, as what my great finance professor did all those years ago in our finance class, I will use this opportunity to explain what the PSEi is and how investors like us can use it to make better investment decisions.

1. What is the PSEi? 

In its simplest sense, the PSEi reflects the general "health" of the stock market; it's high when stock prices are high, and low when stock prices are low. With the index, investors can gauge the overall condition of the stock market without having to look at the prices of a bunch of stocks since this information is already built into the index.

Technically, the PSEi is a collection of the 30 "most important" stocks in the exchange; inclusion in the index is based on a specific set of criteria, but is primarily based on the stock's total market capitalization of the firm (number of shares outstanding multiplied by the stock price) and how actively the shares of the company are traded in the exchange.

2. How are the component stocks of the PSEi selected?

As was already mentioned, the most important determinants of the inclusion of a stock into the index are size and trading volume. Based on these and other criteria, the composition of the PSEi is reviewed every May and November of the year.

3. What is the current composition of the PSEi?

As of May 2011, the PSEi is composed of the following stocks:
  1. Aboitiz Equity Ventures (AEV)
  2. Aboitiz Power (AP)
  3. ABS–CBN Corporation (ABS)
  4. Alliance Global Group, Inc. (AGI)
  5. Ayala Corporation (AC)
  6. Ayala Land (ALI)
  7. Banco de Oro Unibank, Inc. (BDO)
  8. Bank of the Philippine Islands (BPI)
  9. DMCI Holdings (DMC)
  10. Energy Development Corporation (EDC)
  11. Filinvest Land (FLI)
  12. First Gen Corporation (FGEN)
  13. First Philippine Holdings Corporation (FPH)
  14. Globe Telecom (GLO)
  15. International Container Terminal Services Inc. (ICT)
  16. JG Summit Holdings (JGS)
  17. Jollibee Foods Corporation ( JFC)
  18. Lepanto Consolidated Mining Company (LC / LCB)
  19. Manila Electric Company (MER)
  20. Manila Water Company (MWC)
  21. Megaworld Corporation (MEG)
  22. Metro Pacific Investments Corporation (MPI)
  23. Metropolitan Bank and Trust Company (MBT)
  24. Philex Mining Corporation (PX)
  25. Philippine Long Distance Telephone Company (TEL)
  26. Robinsons Land Corporation (RLC)
  27. Security Bank Corporation (SECB)
  28. SM Investments Corporation (SM)
  29. SM Prime Holdings (SMPH)
  30. Universal Robina Corporation (URC)
4. How is the index computed?

The index is computed in real time using this formula:

The "free float shares" of a company are outstanding shares which are freely traded in the market, as opposed to shares which are closely held by major stockholders of the firm.

As you can see from the formula, changes in the PSEi are just based on the changes in the prices of the component stocks. The base level of the index is 1,022.045 reckoned on February 28, 1990, the PSEi's base date (its starting point at t = 0).

5. How can investors use the PSEi to make investment decisions?

Since the PSEi provides a snapshot of the general level of stock prices, investors, especially those who invest in investment funds that mimic the performance of the market as a whole, can use it to time market entry or exit (or when to buy or sell). Analysts can also use trends in historical PSEi levels to forecast the future movement of the market (an exercise that is considered futile by some), or to compute for quantities like "beta" that are essential in fundamental analysis.

6. What's the answer to JP's question?

I just realized that I haven't really answered your question yet :), but based on the formula above, it's clear that the answer is C. The weights of the stocks in your portfolio should be based on the free-float shares of the component stocks of the index. However, I hope that you're not actually planning to construct such a portfolio on your own; it's more convenient and maybe even cheaper to just invest in a diversified portfolio of stocks like UITFs since these fund providers benefit from economies of scale and you most probably won't.

That's it. I hope our readers will now be able to better understand financial news that often use the PSEi in discussing the economy or the stock market. Hopefully, we would be able to eventually learn and be comfortable enough to use this information to make informed investment decisions.

And I hope I was able to adequately answer your question, JP. You may want to refer to the Guide to PSE Indices for a more detailed discussion of the above points.

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