Understand what a capitalisation weighted index is and how it reflects market performance based on company size.
A capitalisation-weighted index is a type of stock market index where each constituent stock is weighted according to its market capitalisation. These indices reflect real market dynamics by giving more influence to larger companies, making them widely followed by investors and analysts alike.
This index assigns a weight to each stock based on its market capitalisation, which is calculated as:
Market Cap = Share Price × Number of Outstanding Shares
Larger companies thus carry greater influence over the index’s performance, while smaller companies contribute less. This methodology offers a realistic representation of overall market sentiment by tracking the most influential businesses.
To calculate a capitalisation-weighted index, follow this formula:
Index Value = (Σ (Price × Shares Outstanding) for all stocks) ÷ Divisor
This formula ensures consistency even when stock splits, dividends, or other corporate actions occur. Here's a simplified tabular example:
| Stock | Price (₹) | Shares Outstanding | Market Cap (₹) | Weight in Index (%) |
|---|---|---|---|---|
| Company A |
100 |
1,00,000 |
1,00,00,000 |
50% |
| Company B |
200 |
50,000 |
1,00,00,000 |
50% |
Total Market Cap (₹) = 2,00,00,000
Total Weight in Index (%) = 100%
This means both companies have equal influence in this specific index because their market caps are the same, despite the price difference.
This weighting method offers multiple benefits that make it popular in index construction:
Reflects real market structure, as larger companies affect the economy more
Tracks investor sentiment through large-cap movements
Is automatically self-adjusting, as prices and caps change
Is the standard for most passive investment products
Due to its alignment with market structure, this method is commonly used in major benchmarks like the Nifty 50 or S&P 500.
Understanding the trade-offs helps investors align index strategy with their investment goals.
| Method | Advantages | Limitations |
|---|---|---|
| Capitalisation-Weighted |
Reflects market reality, widely accepted, scalable |
Overweights large caps, underrepresents smaller companies |
| Equal-Weighted |
Promotes diversification, gives all companies equal chance |
Ignores real market value, frequent rebalancing needed |
| Price-Weighted |
Simple calculation, historical usage |
Skewed by high-priced stocks, not indicative of company size |
Understanding the trade-offs helps investors align index strategy with their investment goals.
| Method | Advantages | Limitations |
|---|---|---|
| Capitalisation-Weighted |
Reflects market reality, widely accepted, scalable |
Overweights large caps, underrepresents smaller companies |
| Equal-Weighted |
Promotes diversification, gives all companies equal chance |
Ignores real market value, frequent rebalancing needed |
| Price-Weighted |
Simple calculation, historical usage |
Skewed by high-priced stocks, not indicative of company size |
Other index methodologies include:
Equal-Weighted Index: Each stock has the same weight, regardless of market cap
Price-Weighted Index: Weight is based purely on stock price (e.g., Dow Jones)
Fundamentally Weighted Index: Weighting based on financial metrics like earnings or revenue
Each approach varies in risk exposure, sector distribution, and rebalancing needs, making it vital to assess based on one’s investment objectives.
Cap-weighted indices are commonly used benchmarks in global markets:
Nifty 50 (India): Tracks the major 50 large-cap companies on NSE
SENSEX (India): Represents 30 financially sound companies from BSE
S&P 500 (USA): Tracks 500 of the largest U.S. companies
FTSE 100 (UK): Includes major 100 companies listed on the London Stock Exchange
All of these use market capitalisation to proportionately represent economic influence within their respective economies.
Capitalisation-weighted indices are commonly used in global markets as they closely reflect overall market performance. While they provide a snapshot of major companies’ market movements, investors must also be aware of their biases—particularly towards large caps. Understanding how these indices are constructed and calculated helps investors interpret market trends more accurately.
This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.
Free-float adjustment modifies the market cap by excluding promoter-held or restricted shares, ensuring the index reflects the actual tradable portion of shares.
Cap-weighted indices are widely used in passive investing because they require minimal rebalancing and naturally align with market movements.
It can overweight a few large-cap companies, causing the index to be skewed and less diversified, particularly during market bubbles or sector booms.
Price-weighted indices assign weight based solely on share price, not market cap. This can lead to disproportionate influence from high-priced stocks regardless of size.
Examples include Nifty 50, SENSEX, S&P 500, FTSE 100, and NASDAQ-100. These indices are benchmark standards for their respective markets.