|Shares (stocks):||Documented partial ownership of a publicly traded company that has raised funds by selling a percentage of itself on a stock exchange’s primary market. Common shares provide the shareholder with the right to vote at board meetings but hold him/her partially responsible for possible losses. Preferred shareholders have no such rights and are therefore remunerated from the proceeds of a potential liquidation before common shareholders.|
Stock market weighting
Stock Market Weighting - text
Each stock in an index is usually given a level of weight, or importance. When there is no weighting method used it is called an ‘Equal-Weighted Index’ as all companies carry the same level of importance whether they are a large company or small.
This type of method is unusual however and the most popular indices have some form of weighting applied.
A price weighted index is where each stock is weighted according to its price only i.e. the price of the stock is all that is considered when weighting that company in the index.
Therefore a stock trading at $100 per share (company A) is 5 times more of the total index than a stock trading at $20 per share (company B). This means that a price move in company A’s shares is likely to have a much bigger impact on the index than a price move in company B’s shares.
Examples of price-weighted indices include the Dow Jones 30 and the Nikkei 225.
One of the shortfalls of the price-weighted method is that it doesn’t consider the overall size and market value of the company. The capitalization-weighted method will weigh companies based upon the total market value of all their shares i.e. share price times the amount of outstanding shares.
In our previous example we said that company A will have a greater weight on the index because its share price is 5 times greater than company B’s under the price-weighted model. However, a company’s true value is not reflected solely in its share price, and company A might be a smaller company than company B.For example, if company A has only 100,000 outstanding shares then its market capitalization (market cap) is $10m. But if company B has 1m outstanding shares then it has a market cap of $20m.
So under a capitalization-weighted index, company B is given twice the weight of company A.
A capitalization-weighted index can also be called a market-value weighted index. Capitalization-weighted indices are the most popular type of index and examples include the S&P 500, FTSE 100, CAC 40 and DAX 30.