The TSX: What is it really?

Executive Summary

Each day, the overall performance of Canadian equities is judged by whether the Toronto Stock Exchange (TSXE) goes up or down. ‘What is the number?’, ‘What does it mean?’ and ‘How is it calculated?’ are all important questions to ask.

The S&P/TSX Composite Index (TSX) is the indicator that is quoted daily. S&P is an abbreviation of Standard and Poor’s, a division of McGraw-Hill, the US based financial reporting, analysis and publishing firm. S&P provides a near endless number of market indices as well as sector and industry sub-indices. The TSX was established in 1977.

The TSX index is comprised of 251 of the largest companies that are listed and actively traded on the Toronto Stock Exchange out of the more than 1,500 total TSX firms.

Each day, as the price of each TSXE company’s shares float up and down based on actual transactions, the TSX is continuously calculated throughout the day, providing a snapshot of whether the stock market in Canada is, in general, going up or down.

At the end of the day, the closing price for each stock contributes to the closing number of the TSX. Typically, each day’s closing amount is compared to the preceding day’s closing amount, and is expressed as either ‘up’ or ‘down’ for the day, or ‘green’ or ‘red’, respectively.

What you need to know

The TSX is derived by performed a number of complicated calculations on firms and stocks that must meet specific eligibility criteria. S&P needs 27 pages to explain the methodology utilized to calculate the TSX, and you can read them here:  https://web.tmxmoney.com/assets/docs/indices/TSX/Methodology_TSX.pdf. This document includes contact information for questions, but a summary should suffice for nearly every investor.

To begin, companies must qualify – then, their stocks and market capitalizations are calculated. Occasionally (usually quarterly) companies are added to the TSX Composite Index based on their eligibility. 

If a company is removed from the TSX, it usually occurs two to five business days after they cease to qualify. In addition to the eligibility requirements (below), a firm will be excluded from the TSX index if trading or financial reporting irregularities transpire.

Eligibility

·      Market Capitalization - a stock must comprise at least 0.05% of the index, and have a minimum average price per share of $1 CDN.

·      Liquidity - a company’s shares must be actively traded with the number of shares that are traded (bought and sold) within the last 12 months equal to at least half the available shares to be traded.

o  If a company has 10 million shares then the number of shares bought and sold in the previous year must be 5 million

·      Domicile – members of the TSX must be incorporated, formed or established in Canada, with financial statements and other securities filings occurring with a provincial regulator as the primary jurisdiction, listed on the Toronto Stock Exchange, and have a substantial presence (head office, principal executive offices or a substantial portion of its fixed assets and revenue) in Canada.

Calculation

·      Multiple classes of stock are included for each eligible company, and each class of share must also qualify using the eligibility criteria for market capitalization and liquidity. It is possible for some, but not all of a company’s share classes to be included in the TSX.

·      The calculations for liquidity are based on the “float” volume of a stock. Controlling blocks, which are those shares that are held by one entity that are greater than 10% of the total outstanding shares, are excluded. 

o  Since the stock owned by major investors (or founders and their families) don’t always trade openly, only those shares that do trade are used in the calculations.

o  The price of a share is multiplied by the number of outstanding shares (less control blocks) to determine that company’s contribution to the TSX.

o  This is repeated for each eligible share class for each company to determine the total floating market capitalization for the TSX.

Nearly 70% of the TSX is comprised of Financials, Energy and Materials firms. Since each of the firms in any particular sector are affected similarly, a good or bad day for one of the top three sectors can influence the performance for the entire TSX.  

source: TMX online

Broad factors like inflation or economic growth data, interest rate actions by central banks, geo-political events, global market changes and commodity price changes can produce major moves in the TSX, or any other index like the US S&P 500, Dow Jones Industrial Average or the NASDAQ.

For example, North American markets gained rapidly and reached historic high levels after Donald Trump was elected President. His promises to reduce regulation and corporate taxes led investors to believe that almost all sectors would advance. A more typical example would be a central banker increasing the benchmark lending rate that would positively affect financial firms. In this case, the financials sector could lead the entire index upward.

In total, the 251 constituent companies that comprise the TSX Composite Index have a market capitalization of $2.1 trillion. The largest 10 companies have over $800 billion or 39% of the total market capitalization.

Most investors are not surprised by the top 10: Royal Bank, TD Bank, Bank of Nova Scotia, Enbridge, CN Rail, Suncor, Bank of Montreal, BCE (Bell Canada), TransCanada Corp and Canadian National Resources.

The Bottom Line

The overall performance of a stock market is a fair indicator of the health of a country’s economy. If the companies are doing well, they are likely operating in a favorable business environment. 

However, an individual company’s current and predicted performance is the true measure of a stock’s potential to provide investment returns. Unless an investor owns a fund that replicates the index, knowing whether the market went ‘up’ or ‘down’ would only be a broad approximation of an investor’s portfolio performance on any given day.