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
- 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.
- 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.
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All views and opinions articulated in the article were expressed in Willie’s personal capacity and do not in any way represent those of his employer and other related entities. Willie does not own any shares in the companies mentioned above.
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