In the previous article, How Do We Calculate a Stock Index, we gave an example on how a price-weighted index is being calculated. In this continuation of a 3-part series, we are going to look into calculating the value-weighted index.

Value-weighted or market capitalization index another of the 3 basic index weighting schemes. It is calculated based on each stock’s equity value in the index – which is the multiplication of a stock price and the total number of shares outstanding and is also adjusted for stock splits, reverse stock splits and dividends. The performance of a value-weighted index would thus represent a portfolio which owns all the outstanding shares of the index.

Float-weighted Index Sub-Category

A sub-category to the value-weighted index is the float-weighted index which adjusts the market cap weights for individual stock’s floating supply of shares, that is only the shares which the public can buy/sell will be used for the index calculation. Corporate cross-holdings, large holdings held by the founding shareholders and government holdings of shares in partly-private companies are usually excluded.

Biases to the Value-weighted Calculations

A value-weighted index tend to be biased toward the shares of companies with the largest market capitalization. For example, a 15% share price increase for a blue chip company would affect have a greater effect on the index as compared to a 15% increase in a smaller company. As such, there will tend to be biases toward large and mature companies and/or overvalued companies whose share prices have already rallied the most.

Examples of a Value-Weighted/Float-Weighted Indices

1. TOPIX (Value-weighted) – representing all the listed companies on the Tokyo Stock Exchange 1st Section.

This contains a large number of several small and illiquid stocks.

1. S&P TSX Composite(Float-weighted) – representing the market cap stocks listed on the Toronto Stock Exchange.

This is widely used as a Canadian equities benchmark.

Value in Action

A value-weighted index is one of the stock index weighting methods used to measure an index’s performance. Its sub-category, float-weighted index adjusts for the shares which can be traded freely.