WHAT IS Price-Weighted Index
A price-weighted index is a stock index in which each stock influences the index in proportion to its price per share. Adding the price of each stock in the index and dividing by the total number of stocks determines the index’s value. A stock with a higher price will be given more weight than a stock with a lower price and, therefore, will have a greater say in the index’s performance.
BREAKING DOWN Price-Weighted Index
In a price-weighted index, a stock that increases from $110 to $120 will have a greater effect on the index than a stock that increases from $10 to $20, even though the percentage move is greater than that of the lower-priced stock. Higher-priced stocks exert a greater influence on the index’s, or the basket’s, overall direction.
One of the most popular price-weighted stocks is the Dow Jones Industrial Average (DIJA), which consists of 30 different stocks, or components. In this index, the higher price stocks move the index more than those with lower prices, thus the price-weighted designation.
Other weighted indexes
In addition to price-weighted indexes, other basic types of weighted indexes include value-weighted indexes and unweighted indexes. For a value-weighted index, like those in the MSCI family of strategy indexes, the number of outstanding shares is a factor. To determine the weight of each stock in a value-weighted index, the price of the stock is multiplied by the number of shares outstanding. For example, if Stock A has 5,000,000 outstanding shares and is trading at $15, then its weight in the index is $750,000,000. If Stock B is trading at $30, but only has 1,000,000 outstanding shares, its weight is $30,000,000. So, in a value-weighted index, Stock A would have more say in how the index moves than Stock B.
In an unweighted index, all stocks have the same impact on the index, no matter 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%, or 30+20+10 / 3, i.e., the number of stocks in the index.
Another type of weighted index is the market capitalization-weighted index, where the shares of each stock are based on the market value of the outstanding shares. Other types of weighted indexes include revenue-weighted, fundamentally-weighted and float-adjusted. All have their positives and negatives, depending on the investor’s goals and market knowledge.