A price-weighted index is a stock index where each company included in the index makes up a fraction of the total index proportional to that company’s share price. In its simplest form, the index’s value is determined by adding the prices of all the stocks in the index and dividing by the total number of companies.
A stock with a higher price will have more weight and thus a more significant influence on the index’s performance relative to lower-priced stocks.
Key Takeaways
- In a price-weighted stock index, each company’s stock is weighted by its price per share, forming an average of the share prices of all the companies.
- Price-weighted indexes give greater weight to higher-priced stocks, influencing the index value and its changes more significantly.
- A price-weighted index can be used to track the average stock price of a given market or industry.
Understanding a Price-Weighted Index
In a price-weighted index, a stock that increases from $110 to $120 will have the same effect on the index as a stock that increases from $10 to $20, even though the percentage move for the latter is more significant. Higher-priced stocks exert a greater influence on the index’s overall direction.
To calculate the value of a simple price-weighted index, sum the share prices of the individual companies, and divide by the number of companies. In some averages, the divisor is adjusted to maintain continuity during stock splits or changes to the list of companies included in the index.
Price-weighted indexes are helpful because the index value is equal to or proportionate to the average stock price for the companies included. This feature allows the construction of indexes that track the average stock price performance of a specific sector or market.
One of the most popular price-weighted stocks is the Dow Jones Industrial Average (DJIA), consisting of 30 different stocks. In this index, higher-priced stocks move the index more than those with lower prices, signifying the price-weighted designation. The Nikkei 225 is another example of a price-weighted index.
Other Weighted Indexes
In addition to price-weighted indexes, other types of weighted indexes include value-weighted indexes and unweighted indexes. For a value-weighted index, such as those in the MSCI family of strategy indexes, the number of outstanding shares is a factor. To determine each stock’s weight in a value-weighted index, the stock price is multiplied by the number of shares outstanding.
For example, if Stock A has five million outstanding shares and is trading at $15, then its weight in the index is $75 million. If Stock B trades at $30 but has only one million outstanding shares, its weight is $30 million. Thus, in a value-weighted index, Stock A would influence the index more than Stock B.
In an unweighted index, all stocks have the same impact on the index, regardless of their share volume or price. Any price change in the index is based on the return percentage of each component. For example, if Stock A is up 30%, Stock B is up 20%, and Stock C is up 10%, the index is up 20%, calculated as (30 + 20 + 10)/3 (the number of stocks in the index).
Other types of weighted indexes include revenue-weighted, fundamentally weighted, and float-adjusted. Each type has its strengths and weaknesses, depending on the investor’s goals and market knowledge.
Related Terms: stock market index, value-weighted index, equity index, fundamentally weighted index.
