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Value-Weighted Index: Definition, Calculation & Examples

Value-Weighted Index: Definition, Calculation & Examples
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  • 0:04 Stock Index
  • 1:20 Value Weighting a Simple Index
  • 4:12 Stock Prices Change
  • 5:54 Lesson Summary
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Lesson Transcript
Instructor: James Walsh

M.B.A. Veteran Business and Economics teacher at a number of community colleges and in the for profit sector.

A value-weighted index assigns a weight to each company in the index based on its value or market capitalization. Follow the example and you will learn how a value weighted index number is calculated.

Stock Index

Ike is a securities analyst for a brokerage firm. He has created a small index for a few local companies called the Ike Index. An index tracks the stock price performance of a group of companies. So instead of looking up a bunch of different stock prices to see how the local ones are doing, interested investors can just look at the Ike Index to see if the group is doing well or poorly. It's just like the market averages you hear reported on radio and TV all the time, only smaller. He sends his results out every day to clients and colleagues who are interested in the health of the local economy.

Ike is getting ready to make some big changes to how he calculates his index numbers. His clients would like to see the index weighted, or how much each individual company has on the index number, to make the larger companies count for more than the smaller ones, since the biggest companies have the most influence on the local job market and economic health. In other words, they want the bigger companies to have more weight, or influence, on his index number.

Many of the most widely followed stock market indices are value-weighted. That includes The NASDAQ Composite Index, and the Wilshire 5000 Total Market Index.

Value-Weighting a Simple Index

Ike knows the solution from what he learned in college. He'll assign a weight to each company in the index based on the company's value. This weight will determine how much influence each company will have on the results. Investors value a company based on its market capitalization, which is the price of its stock times the number of shares outstanding. Bigger companies are more valuable, so they have a higher market capitalization.

Let's look at a sample index for three of Ike's companies to see how the process works. The first thing he does is look up the three companies' stock prices and number of shares outstanding. Then he multiplies them together to get the market capitalization for each. Take a look at the table below to see how that looks:

Company Stock price Shares outstanding Market capitalization
Company A $200 500,000 $100,000,000
Company B $125 1,000,000 $125,000,000
Company C $50 200,000 $10,000,000

Now to get the weights for each company, first add up the market capitalization for each company to get the total. Then take each company's market capitalization and divide it by the total to get its weight. For example, Company A's weight = $100,000,000 / $235,000,000 = 43%. The results for all three look like the updated table:

Company Stock price Shares outstanding Market capitalization Weight
Company A $200 500,000 $100,000,000 43%
Company B $125 1,000,000 $125,000,000 53%
Company C $50 200,000 $10,000,000 4%

As you can see, total market capitalization = $235,000,000

Note how small company C has a much lower weight than the bigger companies - 4% compared to the 43% of Company A and the 53% of Company B. That means Company C will have a much smaller impact on the index.

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