Indexes, Price vs Cap-weighted

April 26, 2021

Now, I want to share some insights with you regarding indexes. 

The Dow 30, commonly referred to as the "Dow," or the "Dow Jones Industrial Average,", is an American stock market index tracking 30 large, publicly traded companies 

The combined stock price of these 30 large, publicly traded companies determines the Dow Jones Industrial Average (DJIA). Since some of the top stocks in the marketplace is part of the index, several believe that the Dow 30 represents a strong assessment of the American market's overall health and tendencies. 

This index, the DJ Industrial is a price-weighted index. It means that each of the 30 companies in the index is represented by one share only. The company with the highest stock share price, weighs the most and thus impacts the index the most. The company with the lowest price weighs the lowest. 

Two of the companies in the index are UnitedHealth and the bank JPMorgan. They have almost the same market value. However, in the DJ Industrial index, the health company weighs more than 3 times as much as the bank, because the price of the share is 314 dollars compared to 97 dollars of the bank. 

Another way of creating an index is to let the index be based on the market value of the companies that are included in the index. The market value is in the finance world known as market capitalization, which is the total dollar market value of a company's outstanding shares of stock. In indexes based on market capitalization, companies with a higher market value will weigh more than less valuable companies. 

The critics of the Dow Jones index believe it poorly represents the U.S. market as it only contains 30 large-cap companies and is not weighted by market capitalization.  

The S&P500 Index on the other hand, is a weighted index. This index is also considered to be an overall representation of the American stock market. From the beginning of 2020 to late August, it rose 5,15 % to a new all-time high.  

The record does however hide an enormous spread between the 518 shares in the index. Only 226 of the companies rose in value, and for 291 of the 518 companies, the price fell. Bloomberg, a financial analysis and news company, found out that the technology giants such as Apple, Amazon and Microsoft have contributed to the price increase of the index’ the most.  

There are however some companies dragging the value down. The banks JPMorgan and Wells Fargo, and the oil company Exxon Mobil, have contributed negatively to the price. 

The COVID 19 pandemic hit different businesses, industries, and markets very differently. Since the American market has shown strength after the initial burst of the COVID19 virus, it is because the technology companies have such a high weight in the index. 

What does all of this mean to you? Indexes can help you get an understanding of what is going on in the market, and to find your next investment opportunity. In this way, you can become recession-proof. You can create an additional income stream! 

Thank you for reading and I hope you check back in for the next blog! 

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