NIKKEI 225 INDEX OVERVIEW

The Nikkei 225, also known as the Nikkei Stock Average, is Japan’s most recognised equity index. It represents the performance of 225 large, publicly traded companies listed on the Tokyo Stock Exchange (TSE). First published in 1950, the Nikkei 225 is commonly used as a barometer for the Japanese economy and stock market sentiment, similar to how the Dow Jones Industrial Average functions for the United States.

The Nikkei 225 consists of companies from a wide range of industries, including manufacturing, technology, pharmaceuticals, and financial services. Key companies often featured in the index include multinational giants such as Toyota Motor Corporation, Sony Group Corporation, and SoftBank Group. Despite being an industrial average, the index includes service organisations, consumer brands, as well as technology-related firms, offering a broad reflection of Japan’s modern economy.

Maintained and calculated by Nikkei Inc., a leading Japanese media corporation, the index serves both as an investment benchmarking tool and a reference in global financial markets. Unlike other indices that use a market capitalisation-weighted methodology, the Nikkei 225 employs a price-weighted approach, meaning the index gives higher weight to shares with higher prices, regardless of the company's overall market value.

The companies included in the Nikkei 225 are selected to represent a cross-section of leading firms across Japan’s industrial landscape. Throughout its history, the Nikkei 225 has mirrored Japan’s evolving economic priorities, integrating new sectors as they gain prominence. Representative industries include technology, automobiles, consumer electronics, telecommunications, pharmaceuticals, and financial services.

Although the Nikkei 225 does not represent the entirety of Japan’s equity market — which includes more than 3,700 companies on the TSE — it remains one of the most influential indicators of Japanese financial and corporate performance. It is widely used by investors, analysts, and institutions around the globe to monitor market trends and guide investment decisions in the Asia-Pacific region.

The Nikkei 225 follows a price-weighted calculation method, aligning more closely with the traditional Dow Jones Industrial Average than modern capitalisation-weighted indices like the S&P 500 or the TOPIX (Tokyo Price Index). In a price-weighted structure, each constituent’s stock price determines its impact on the index. Thus, companies with higher share prices exert a greater influence on the overall index movement, regardless of their total market capitalisation.

The formula used for the Nikkei 225 calculation is relatively straightforward:

• Index Value = (Sum of Adjusted Stock Prices) / Divisor

The divisor is a numerical figure used to maintain the index’s continuity when constituents are altered due to stock splits, company mergers, or other structural changes. It ensures that such corporate actions do not skew the index’s historical value, allowing for consistent tracking over time.

The calculation is performed every 15 seconds during trading hours on the Tokyo Stock Exchange, providing a near real-time snapshot of market performance. One important implication of the price-weighted methodology is that high-priced stocks can disproportionately influence the index, even if their movements do not reflect broader market sentiment.

This approach has both benefits and drawbacks. On the one hand, it simplifies the computation process and maintains historical continuity. On the other, critics argue that it does not accurately reflect the economic footprint of larger firms with lower share prices. For example, a tech giant with lower-priced shares could have less weight in the index than a smaller company with higher share prices.

Additionally, the use of unadjusted prices means the index does not factor in dividends received by investors, unlike total return indices which incorporate reinvested dividends. This can affect long-term comparability when assessing investment performance. Despite its quirks, the Nikkei 225 remains highly respected for charting Japan’s business and stock market evolution.

The Nikkei 225 is composed of 225 selected stocks from the Prime Market segment of the Tokyo Stock Exchange, formerly known as the First Section prior to structural reforms in 2022. The selection aims to ensure sector balance and representativeness of Japanese corporate performance, rather than pure market size.

The selection process is managed by Nikkei Inc., which reviews the index’s composition annually, typically in October. The review assesses the eligibility of each company based on liquidity, sector representation, and financial stability. Companies with limited trading volumes or those not sufficiently representative of their sector or the broader economy may be replaced.

When changes are made, the transitions are communicated clearly and implemented promptly. Adjustments might occur due to several corporate events:

• Mergers or acquisitions leading to a stock being delisted
• Significant deterioration in business metrics or liquidity
• Strategic decision to promote newer industry participation

In choosing replacements, Nikkei Inc. evaluates candidates from both a qualitative and quantitative standpoint, considering sector balance to ensure diversification. For example, companies from emerging sectors like automation, e-commerce, or renewable energy might be added to reflect shifts in the Japanese economy.

Despite the rigid number of constituents, the industry landscape within the index is periodically adjusted. The rebalancing process also considers the impact of corporate actions, such as stock splits and rights offerings, which may affect share prices directly. The index's divisor is then recalibrated accordingly, keeping the index value stable and historically comparable.

The Nikkei 225 maintains transparency in its methodology and regularly publishes reports and updates detailing any changes. These updates are closely watched by index fund managers, ETFs, and institutional investors who seek alignment with the benchmark for tracking or predictive purposes.

Being a legacy index in operation for over 70 years, the Nikkei 225 continues to adapt to economic change while holding onto its distinctive calculation methodology. Its combination of tradition and real-time data utility makes it a staple for interpreting Japan’s financial direction and corporate health.