What is a 'Composite Index'?

A composite index is a grouping of equities, indexes or other factors that are combined in a standardized way to provide a useful statistical measure of overall market or sector performance over time. It is also known simply as a "composite." Typically, a composite index has a large number of factors that are averaged together to form a product representative of an overall market or sector.

BREAKING DOWN 'Composite Index'

For example, the Nasdaq Composite index is a market capitalization-weighted grouping of approximately 5,000 stocks listed on the Nasdaq market. These indexes are useful tools for measuring and tracking price level changes to an entire stock market or sector. Therefore, they provide a useful benchmark against which to measure an investor's portfolio. The goal of a well-diversified portfolio is usually to outperform the main composite indexes.

Market Capitalization-weighted Composite Example

In a capitalization-weighted composite, each component's total market capitalization is proportionately used to determine the index level. In this calculation methodology, components with higher market capitalizations will have more weight in the composite while components with lower market capitalizations will have less weight in the composite. For example, for stocks, the price per share of each company is multiplied by its total number of shares outstanding to arrive at its total market capitalization. For example, consider the following:

Stock A: Price per share equals $25 and total shares outstanding equal 1,000,000

Stock B: Price per share equals $50 and total shares outstanding equal 500,000

Stock C: Price per share equals $50 and total shares outstanding equal 1,000,000

Their respective markets capitalizations would be:

Stock A = $25 x 1,000,000 = $25,000,000

Stock B = $50 x 500,000 = $25,000,000

Stock C = $50 x 1,000,000 = $50,000,000

Thus, the total market capitalization of the composite would be $100,000,000. Stock A's weight would be 25%, Stock B's weight would be 25%, and Stock C's weight would be 50%. Typically, a divisor would be used to render the index manageable for reporting purposes. In this case, the divisor would be $100,000, and the initial composite level would be equal to $100,000,000 / $100,000 = 1,000

Price-Weighted Composite Example

In a price-weighted index, components are weighted by price, not by market capitalization or shares outstanding. The Dow Jones Industrial Average (DJIA) is the most popular price-weighed composite. Components with higher prices receive higher weightings in the composite. For example, for the following list of five stocks:

Stock A: price equals $3

Stock B: price equals $6

Stock C: price equals $30

Stock D: price equals $10

Stock E: price equals $1

The composite level would be found by summing the components and dividing by the number of components. In this case, the composite level would be 50.

RELATED TERMS
  1. Capitalization-Weighted Index

    Capitalization-weighted index is a market index in which stocks ...
  2. NYSE Composite Index

    The NYSE Composite Index serves as a gauge of the performance ...
  3. Weighted

    Weighted is a description of adjustments to a figure to account ...
  4. Equal Weight

    Equal weight is a type of classification that gives the same ...
  5. Market Index

    A market index is a weighted average of a section of the stock ...
  6. NASDAQ Global Market Composite

    The NASDAQ Global Market Composite is a stock market index of 1,45 ...
Related Articles
  1. Investing

    Choosing The Right ETF Index To Reach Your Goals

    The key to choosing ETFs for your portfolio is understanding how they pick stocks and making sure their investment philosophy matches yours.
  2. Investing

    Investigating the Effectiveness of Equal-Weight ETFs

    Investors should know the ins and outs of equally weighting stocks before considering the related ETFs.
  3. Investing

    Introduction To Fundamentally Weighted Index Investing

    If you believe the market smiles on those who focus on value, growth or income, this vehicle may be for you.
  4. Insights

    Key indicators for following the stock market and economy

    Learn about some of the key indicators analysts use to follow the U.S. stock markets and to assess the overall condition of the U.S. economy.
  5. Investing

    Spread Out Risk With Sector-Based ETFs

    These ETFs take the sector rotation strategy from institutional investors and puts it in your hands.
  6. Investing

    Strategies For Determining The Market's True Worth

    Learn the strengths and weaknesses of passive and active management when trying to uncover the overall market's worth.
  7. Investing

    Index Investing

    Get to know the most important market indices and the pros and cons of investing in them.
  8. Investing

    Smart Beta vs. Active Management: Which is Better? (BLK, SCHB)

    Learn how smart beta funds combine the advantages of both active and passive management by tracking customized indexes without capitalization weighting.
RELATED FAQS
  1. What does the S&P 500 index measure and how is it calculated?

    Learn about what exactly the S&P measures and why it's used by market participants as a tool to understand the broader stock ... Read Answer >>
  2. Weighted Average Shares Vs. Outstanding Shares

    What's the difference between weighted average shares outstanding and basic weighted average shares? Read Answer >>
  3. What is the weighted average of outstanding shares? How is it calculated?

    The weighted average of outstanding shares is a calculation that incorporates any changes in the amount of outstanding shares ... Read Answer >>
  4. Why is the Dow Jones Industrial Average (DJIA) price weighted?

    Learn how the Dow Jones Industrial Average has told the story of the broad market through its simple, price-weighted calculation ... Read Answer >>
  5. What does the Dow Jones Industrial Average measure?

    The Dow Jones Industrial Average (DJIA) is a price-weighted index that measures the daily price movements of 30 large American ... Read Answer >>
Trading Center