How to Create a Stock Index
Calculating a stock index is a useful exercise if you wish to see the relative performance of a basket of stocks over time. A stock index does not necessarily tell you what value a group of stocks is trading at, but it does tell you how that group of stocks has performed since you began tracking its performance. Stock indexes are powerful tools that allow you to compute the percent change in a pool of investments over a given period.
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Instructions
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1
Select a group of stocks to include in the index. To make the index worthwhile, you should include at least five stocks in the index.
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2
Calculate each stock's weighting in the index by multiplying the price per share by the number of shares outstanding for each stock. For example, suppose you wanted to create a very simple index with two stocks. Stock A is trading at $10 per share and has 1,000 shares outstanding while Stock B is trading at $12 per share and has 1,500 shares outstanding. The weighting for Stock A would equal $10 x 1,000 = 10,000 while the weighting for Stock B would equal $12 x 1,500 = 18,000.
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3
Sum the weightings. This sum is the value of the index at Time 0 (the day on which you begin tracking the performance of the group of stocks). The performance of the stocks will be measured, or indexed, to this specific day. In this simple example, the base value of the index at Time 0 equals 10,000 + 18,000 = 28,000.
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4
Repeat Steps 2 and 3 for each trading day for the group of stocks. For this example, suppose that on the second day of trading Stock A rises to $11 in value and Stock B rises to $15 in value. Suppose that the number of shares outstanding for each stock remains the same. The value of the index on the second day is equal to ($11 x 1,000) + ($15 x 1,500) = 33,500.
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5
Divide the value of the index on any given day by the base value of the index at Time 0, calculated in Step 3. This calculation will tell you how the group of stocks has performed relative to the base date. In this example, the index has gone up by 33,500/28,000 = 20 percent.
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Tips & Warnings
When constructing an index, it is best to choose a group of stocks that are similar to one another or are in the same industry. It makes more sense to compare the performance of two airline stocks than to compare the performance of an airline stock and a food company stock since both are in completely different industries that are impacted by different macroeconomic factors.
Always check the number of shares outstanding for each stock in your index when calculating the value of the index on a specific day. If you do not account for changes in the number of shares outstanding, you will have inaccurate weights in your index.
