Price-Weighted Index

A price-weighted index measures market performance by averaging the share prices of its constituent stocks. In this method, stocks with higher per-share prices have greater influence on the index’s movement than lower-priced stocks, regardless of a company’s market capitalization.

How it works

• Basic formula: Index value = (Sum of component stock prices) / Divisor
• The divisor is typically the number of stocks but is adjusted to preserve continuity when events occur (stock splits, special dividends, or component changes).
• Example calculation:
• Four stocks priced $10, $20, $30, and $40 → sum = $100.
• If divisor = 4, index = 100 / 4 = 25.
• If the $40 stock undergoes a 2-for-1 split to $20, the sum becomes $80. To keep the index unchanged, the divisor is adjusted so 80 / new_divisor = 25 → new_divisor = 3.2.

Influence on market trends

• Absolute price change drives index movement, not percentage change.
• A $10 increase in a $110 stock (to $120) and a $10 increase in a $10 stock (to $20) have the same impact on a price-weighted index, even though the latter is a much larger percentage move.
• This gives high-priced shares outsized influence, which can distort how representative the index is of the overall market or sector.

Notable examples

• Dow Jones Industrial Average (DJIA)
• Nikkei 225

Comparison with other index weighting methods

• Value-weighted (market-cap-weighted): weights proportional to market capitalization (price × shares outstanding). Larger companies by market value carry more weight.
• Equal-weighted (unweighted): each stock has the same weight; the index reflects average percentage returns of constituents.
• Other methods: float-adjusted, revenue-weighted, fundamentally weighted—each targets different investment objectives and biases.

Pros and cons

Pros:
– Simple to calculate and understand.
– Useful when tracking average share-price movement of a selected group.

Cons:
– Can misrepresent market performance because high-priced stocks dominate the index regardless of company size or economic importance.
– Requires divisor adjustments for corporate actions, adding a layer of maintenance.

Key takeaways

• Price-weighted indexes emphasize per-share price, not company size.
• Absolute price changes, not percentage moves, determine influence on the index.
• They are easy to compute but can produce misleading signals compared with market-cap or equal-weighted indexes.
• Knowing the weighting methodology helps interpret index movements and informs investment decisions.