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Investors have
embraced stock indexes. There are now stock indexes for every conceivable
investment style, trend and market segment. A market index is a method of
tracking the price performance of a group of securities. There are a myriad
of investments that allow you to participate in the price action of
particular indexes. If your investment is tied to an index, then
understanding the underlying calculations is important.
Calculation Methods
- Price Weighted
– The aggregate individual prices of the stocks in the index are added
together, and divided by the number of companies. A divisor is used to
adjust for stock splits, stock dividends, etc. The focus is the stock
price, not the size of the company. The higher stock prices in the index
have a greater impact then the lower priced stocks. The DJIA is priced
weighted.
- Market
Capitalization Weighted – Market
capitalization weighing occurs when the weight of each security in the
index is in proportion to the stock’s capitalization. More emphasis is
given to the large, high priced or overvalued companies, than to the
smaller or undervalued stocks. Most indexes are market capitalization
weighted.
- Unweighted –
The unweighted method tracks the performance of the underlying stocks,
where equal dollar amounts are invested in each security. The Value Line
Composite Index is the best example of an unweighted index.
Description of the
Major Indexes
Dow Jones Industrial
Average (DJIA) –Developed by
Charles Dow in 1896, it is a group of 30 well established industrial
blue chip companies, which cover most of the economic activities in the
United States. It excludes Transportation and Utility stocks, as they are
followed under separate indices. The DJIA is the oldest of the indexes, and
was kept simple; Charles Dow just took the total of 12 companies’ stock
prices and divided by the number of companies. Of the original 12 companies,
only GE remains in the index. In 1928 the index was increased to 30
companies. The Dow became immortalized on October 28, 1929 and October 29,
1929 as the Dow dropped 24.5% in two days. (It did, however, recover 12.3%
the following day). The plummeting of the Dow is historically viewed as the
watershed event that ushered in the Great Depression.
NYSE Composite Index
– The NYSE Composite Index tracks
the price performance of all the companies listed on the New York Stock
Exchange, and is weighted by market capitalization.
NASDAQ Composite
Index - This index tracks
the price measurement of all the stocks listed on the NASDAQ stock exchange.
The index is market-capitalization weighted.
NASDAQ-100 Index –
The NASDAQ-100 Index tracks the price performance of the 100 largest
non-financial stocks listed on NASDAQ, and the index is based on a modified
market capitalization calculation. Among many eligibility requirements, it
includes only stocks that have an average minimum daily trading volume of
200,000 shares. Rebalancing is reviewed quarterly.
S&P Index
– The S&P 500 index is weighted by market capitalization and tracks the
performance of 500 of the most widely held and most respected U.S. based
companies. Rebalancing is reviewed monthly.
Value Line Composite
Index – This index measures the
performance of the 1700 companies covered in the Value Line Investment
Survey. The index is based on an unweighted index and assumes equally
weighted positions in all 1700 stocks.
Russell Indexes
– The Russell 2000 Index measures the performance of the smallest 2000
companies in the Russell 3000 index. The very small micro-capitalization
stocks are not included in the index. The Russell 3000 includes
approximately 98% of the U.S. market.
These indexes are market capitalization weighted.
Wilshire Indexes –
The Wilshire 5000 Total Market Index tracks the
performance of the 5,000 plus U.S. headquartered companies that have readily available price data. The
Wilshire 4500 Completion Index includes all the securities in the Wilshire
5000, except for those companies that make up the S&P 500. These indexes are
market capitalization weighted. They also have float-adjusted versions,
believed to be more useful benchmarks, which include only those shares that
are available to investors.
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