How Is the NASDAQ Calculated?
Other People Are Reading
-
Overview
-
The NASDAQ is the largest electronic quotation and exchange system in the world. Standing for National Association of Securities Dealers and Quotations, NASDAQ lists 3,200 companies, from small capitalization bio-tech firms to huge household names like Microsoft, Apple, and Cisco. To match its innovative quoting and trading system, NASDAQ utilizes a progressive, capitalization-weighted system for calculating its price.
-
History
-
Many stock indexes, most notably the Dow Jones Industrial Average, are calculated using a price weighting method. This means that the prices of stocks in an index, like the thirty large-cap companies that populate the Dow Jones Industrial Average, are added up and divided by the number of companies in the index to yield the price. This divisor has been modified and become more complex over time to account for stock splits, mergers and acquisitions, buyouts, corporate spin-offs and de-listings. Although still price-based, the divisor is continually revised to filter out unnecessary price swings caused by anything other than natural buying and selling in the marketplace.
Present-Day NASDAQ Calculations
-
To avoid the perceived inefficiencies and inaccuracies of price-weighted calculation, indexes like the NASDAQ have shifted to a market capitalization method of valuation. A company's market capitalization is ascertained by multiplying its share price by the number of shares outstanding. Instead of just looking at prices, the market capitalization model takes into account the overall value of stocks in its index. This is particularly convenient when dealing with events like stock splits and buyouts, in which the number and price of shares changes, but the underlying value of a company doesn't. For example, a company with a stock value of $40 and 20,000,000 shares outstanding has a market capitalization of $800,000,000. If this company were to conduct a 2-for-1 split, its share price would reduce to $20 but it would now have 40,000,000 shares outstanding, leaving it with the same market capitalization of $800,000,000. Since the NASDAQ price is already calculated based on market capitalization, no heavily modified divisor is needed to come up with a new valuation for the index as a whole. The only time the NASDAQ revises its calculation is when one of its component securities leaves the index or is de-listed.
Effects of Market Capitalization Pricing
-
Today, most stock indexes have followed the NASDAQ's lead and use market capitalization pricing. As a result, the prices of these indexes tend to most closely track the price fluctuations of the largest, highest capitalization stocks within them. Some critics feel that this doesn't give an accurate enough reflection of the value and contributions of smaller companies, but others insist that market capitalization weighting is by far the best way to ensure accurate, representative pricing of the index as a whole.
-
Resources
- Photo Credit Business Week
