A price-weighted index is a stock index where the companies in the index form a fraction of the total index relative to that company's stock price per share.
To calculate a price-weighted index in its simplest form you take the price of the total members' stock prices and divide them by the total number of companies in that index.a stock with a higher price will have more influence than a stock with a lower price and, therefore, will have a bigger impact on the index's overall performance.
The dow jones industrial average (djia) is one of the most well-known and most followed indexes in the world. when it was first created the djia consisted of only 12 stocks and was priced at 40.94. today it has increased to 30 stocks, making it one of the least diversified indexes around. although the calculating the dow’s value is not exactly straightforward, the calculation essentially comes from adding up the prices of all 30 companies within the index and dividing that number by the divisor (the "magic number").
Example of price weighted indexfor example, if you want to calculate a price-weighted average of four stocks with prices$200, $100, $85, $30 as follows:$200, $100, $85, $30price weighted average =___________________ = $415 4
Let us say that one of these stocks releases some positive news, and its shares jump by 10%. this would also raise the price-weighted average.
key takeaways
- A price-weighted average is a simple mathematical average of several stock prices.
- The most well-known price-weighted index in the u.s. is the dow jones industrial average.
- The price movements of companies with the highest share price have the biggest impact on the value of the index.