Understanding market-cap, equal-cap and fundamental weighting

MARKET CAP WEIGHTED INDEX

How to Calculate

ASSUME THE STOCK MARKET HAS ONLY THREE COMPANIES:
Market
Capitalization
Last Year’s
Earnings
Company A = $6 billion $100 million
Company B = $3 billion $300 million
Company C = $1 billion $200 million
Total Market Cap
of All Companies
$10 billion Total Earnings
of All Companies
$600 million
MARKET CAP WEIGHTED INDEX
Company A = $6 billion = 60% weight in index
$10 billion
Company B = $3 billion = 30% weight in index
$10 billion
Company C = $1 billion = 10% weight in index
$10 billion
The market-cap-weighted index, as the name implies, weights companies according to market cap. Here, Company A has a market capitalization of $6 billion which is equal to 60% of the total market cap of all stocks ($10 billion).

EQUALLY WEIGHTED INDEX

How to Calculate

ASSUME THE STOCK MARKET HAS ONLY THREE COMPANIES:
Market
Capitalization
Last Year’s
Earnings
Company A = $6 billion $100 million
Company B = $3 billion $300 million
Company C = $1 billion $200 million
Total Market Cap
of All Companies
$10 billion Total Earnings
of All Companies
$600 million
EQUALLY WEIGHTED INDEX
Company A = 33% weight in index
Company B = 33% weight in index
Company C = 33% weight in index
The equally weighted index weights all companies equally, regardless of size. Here, there are three companies in the stock universe, and therefore each gets a one- third weight in the index.

FUNDAMENTALLY WEIGHTED INDEX

How to Calculate

ASSUME THE STOCK MARKET HAS ONLY THREE COMPANIES:
Market
Capitalization
Last Year’s
Earnings
Company A = $6 billion $100 million
Company B = $3 billion $300 million
Company C = $1 billion $200 million
Total Market Cap
of All Companies
$10 billion Total Earnings
of All Companies
$600 million
FUNDAMENTALLY WEIGHTED INDEX
Company A = $100 million = 16.7% weight in index
$600 million
Company B = $300 million = 50% weight in index
$600 million
Company C = $200 million = 33.3% weight in index
$600 million
For the fundamentally weighted index, we used earnings as a measure of economic size. Earnings for the entire universe of companies equaled $600 million, so Company B, with $300 million in earnings, receives a weight of 50% in this fundamentally weighted index. Fundamentally weighted indexes often use additional measures of fundamental size such as cash flow, book value, sales, and/or dividends. Notice that market capitalization (and therefore market price) is not considered for this fundamental index.
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