8.4 Stock Indexes And Averages

Summary: Important Stock Indexes and Averages

Stock indexes or averages are indicators used to measure changes in a representative grouping of stocks, such as the S&P/TSX Composite Index or the Dow Jones Industrial Average (DJIA). These indicators are important tools, and are used for the following purposes:

• Gauge the overall performance and directional moves in the stock market.
• Enable portfolio managers and other investors to measure their portfolio’s performance against a commonly used yardstick within the stock market.
• Create index mutual funds.
• Serve as underlying interests for options, futures, and exchange-traded funds.

A stock index is a time series of numbers used to calculate a percentage change of this series over any period of time. Most stock indexes are value-weighted and are derived by using the total market value (i.e., market capitalization) of all stocks used in the index relative to a base period. The total market value of a stock is found by multiplying its current price by the number of shares outstanding.

Did You Know?

Many organizations that construct indexes have additional construction rules for the indexes they publish. For example, most of the S&P market capitalization-weighted indexes are float-adjusted.

Float: The float refers to common shares issued to the public that are available for trading by investors, and excludes those shares held by company officers, directors, or investors who hold a controlling interest in the company. A float-adjusted index means the index calculation only reflects those shares that are considered to be part of the float.

Each day, the total market value of all stocks included in the series is calculated, and this value is compared to the initial base value to determine the percentage change in the index.

Example Calculation

The S&P/TSX Composite Index closed at a value of 15,562. A year later, the same index closed at a value of 16,385. The change in the index translates into a gain of 5.29% for the year—calculated as follows:

In a value-weighted index, such as the S&P/TSX Composite Index or the S&P 500, companies with large market capitalizations dominate changes in the value of the index over time while companies with small market capitalizations have less of an impact.

Understanding Stock Averages

A stock average is the arithmetic average of the current prices of a group of stocks designed to represent the overall market or some part of it.

Within a stock index, each stock has a relative weight based on the stock’s market capitalization. In contrast to a market-weighted stock index, stocks included in an average are composed of equally weighted items (i.e., no specific weights are applied when constructing the average). A stock’s relative weight within an index can change every day, whereas a stock’s weight within an average is always the same. However, stock averages are price-weighted, which means that movements in the average are tied directly to changes in the prices of the various stocks included in the average. This occurs because some prices are higher than others and will naturally have a greater influence on the average as a whole.

Example Scenario

Even though no specific weights are applied when constructing the average, a stock that trades at $100 per share and falls by half to $50 will have a greater impact on the average than a stock that trades at $10 per share and drops by half to $5.

Key Takeaways

• Stock Indexes and Averages are crucial tools for monitoring stock performance and making investment decisions.
• Stock indexes are often market capitalization-weighted, emphasizing companies with larger market caps, whereas stock averages are price-weighted.
• Float-adjusted indexes consider only the publicly tradable shares, excluding those held by insiders.
• These metrics serve as benchmarks and underlie financial products such as mutual funds and ETFs.

Frequently Asked Questions (FAQs)

Q1: What is the difference between a stock index and a stock average?

A: A stock index is a series of numbers indicating changes in the stock market, usually calculated on the basis of market capitalization. A stock average is an arithmetic mean of prices of a select group of stocks, generally price-weighted.

Q2: How does float adjustment affect an index?

A: Float adjustment refines an index by accounting only for shares that can be traded by the public, removing those held by company insiders or those with control positions, thus providing a more accurate market representation.

Q3: Why do large capitalized companies dominate changes in a value-weighted index?

A: In value-weighted indexes, companies with larger market capitalizations have a greater impact on the index calculations, meaning their price movements cause significant fluctuations in the index value.

Glossary

• Stock Index: A measurement of the value or performance of a specific portion of the stock market.
• Float-Adjusted Index: An index which only includes shares available for public trading.
• Market Capitalization: The total market value of a company’s outstanding shares of stock.
• Price-Weighted Average: An average that gives higher weighting to stocks with higher prices.

Diagrams and Charts

Market Capitalization Example

    graph TB
	    A[Company A, Market Cap: $100B]
	    B[Company B, Market Cap: $50B]
	    C[Company C, Market Cap: $25B]
	    D[Total Market Cap]
	
	    A --> D
	    B --> D
	    C --> D

Float Example

    graph TD
	    Investor1[Public]
	    Investor2[Public]
	    Insider[Insider]
	    A[Public Shares: 300M]
	    B[Insider Shares: 100M]
	
	    Investor1 --> A
	    Investor2 --> A
	    Insider --> B

In this section

• 8.4.1 Canadian Market Indexes
  Comprehensive guide on Canadian Market Indexes including details on S&P/TSX Composite Index, S&P/TSX 60 Index, and S&P/TSX Venture Composite Index.
• 8.4.2 U.S. Stock Market Indexes
  An in-depth overview of major U.S. stock market indexes, including the Dow Jones Industrial Average and the S&P 500. Detailed explanations of their composition, calculations, and their usage as market performance indicators.
• 8.4.3 Other U.S. Stock Market Indexes
  An in-depth guide covering various significant U.S. stock market indexes including NYSE Composite, NYSE American, NASDAQ Composite Index, and Value Line Composite Index.
• 8.4.4 International Market Indexes And Averages
  This section provides a comprehensive understanding of various international market indexes and averages, which are crucial for investors looking to diversify their portfolios globally.