Market Value Vs. Price Weighted Average
The terms market value and price weighted average have similar connotation to stock market indexes. With the onset of retirement accounts and some extra savings to invest, many individuals living in industrialized nations have become interested in the stock market. As most of these people do not invest professionally, the stock market indexes provide a barometer for how their portfolios perform in a short term. These indexes vary in the types and way their firms calculate them. The NASDAQ, the Dow Jones Industrial Average and the S&P 500 highlight the most watched United States indexes. The Dow Jones Index consists of a price weighted average whereas the S&P 500 has a composition of the market capitalization of each component.
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Function
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Many investors use the terms average and index interchangeably. The Dow Average and the Dow Index refer to the same stock market barometer. According to Investopedia, a price-weighted average or index means a stock index in which each stock influences the index in proportion to its price per share. The value of the index is generated by adding the prices of each of the stocks in the index and dividing them by the total number of stocks.
Market value refers to the current quoted price at which investors buy or sell a share of common stock or a bond at a given time according to Investopedia. This market value or price becomes the primary component of a price-weighted average.
Features
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When an analyst values a security, he or she will value the business based on its future growth potential. This calculated value will differ from the book value of the business. The book value only examines the current state of the business or total assets less total debts. Rarely does the market value dip below the book value. The market value reflects the most recent price or transaction for the asset or shares of a business. The market value or price of an asset multiplied by the shares outstanding comprises the market capitalization or overall size of the company. Most stock market indexes use an average weighted market capitalization.
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Warning
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Investors need to understand that the market value can be deceptive. Just because a company currently has a low market value does not mean that the business is small or insignificant. Citibank and Ford have recently had a rough business environment and their market values have dropped. However, these businesses each have a market capitalization in the billions of dollars and employ thousands of people.
Dow Jones Industrial Average
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The oldest and most widely known price weighted average consists of the Dow Jones Industrial Average index. According to Investopedia, the Dow Jones Industrial Average index, a price-weighted average of 30 actively traded blue chip stocks, is comprised primarily of industrial stocks but also includes American Express Co. and American Telephone and Telegraph Co. Prepared and published by Dow Jones & co., The Dow is calculated by adding the closing prices of the component stocks and using a divisor that adjusts for splits and stock dividends equal to 10 percent or more of the market value of an issue as well as substitutions and mergers. The average is quoted in points, not in dollars.
Considerations
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Components of a price weighted average or index typically refrain from splitting their common stock. These stocks tend to have very high prices per share and this costs the average investor more to build a position in the business. The reasoning that may lead a business to choose this strategy is due to the impact their stock price has on the underlying index.
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