A price-weighted index is a type of stock market index used to assess the value of a group of stocks. In a price-weighted index, each stock is given a weight, or rank of influence, based on its outstanding share price. The higher the share price of a stock, the greater weight it is given. In a price-weighted index, the overall value of the group is affected more by the stocks with the greatest share values and less by those with lower values. This type of index is used in several well-known stock market indexes, including the Dow Jones Industrial Average and the Dow Jones Utility Average in the United States.
When looking at a price-weighted index, the key to keep in mind is the share value. Regardless of how large a company is or how many shares outstanding it has, share value is king. For example, say company A has 5,000 shares worth $80 U.S. dollars (USD) each and company B has 100,000 shares worth $20 USD each. Even though company B is worth more based on its overall market value due to the fact that it has many more shares, company A would be weighted higher in a price-weighted index because its individual share price is higher.
Due to this weighting, the change in value of shares affects the average differently for different stocks. In the above example, company A's stock would have four times the impact on the overall value of the average because its share price is four times that of company B. This is in sharp contrast to a market-value weighted index, where the overall market value of the shares of a particular company is what determines the average value of the index. Market value is the number of shares multiplied by the share price. In a market-value weighted index, company B would have more influence than company A because it has a greater overall market value.
A market index can often help investors see the overall direction that stocks in a certain country or area of business are moving. For example, the Dow Jones Industrial Average is a price-weighted index of 30 of the largest companies in the United States. It is often consulted to see how the overall U.S. stock market is performing from day to day or year to year. The Dow Jones Utility Average, which is made up of 15 large utility companies in the U.S., can help give a more focused look just at how U.S. utility companies are generally performing.
