# How to create a simple traditional value weighted index

Let us do this using earnings yield.

Earnings yield= Earnings per share/ Price of share

eg.  If earnings is \$10 and price is \$100 then earnings yield=10/100=1/10=0.1=10%

 Earnings yield ASSUME THE STOCK MARKET HAS ONLY THREE COMPANIES: Company A = 10% Company B = 20% Company C = 30% Total earnings yield of All Companies 60%
 TRADITIONAL VALUE WEIGHTED INDEX Company A = 10% = 16.7% weight in index 60% Company B = 20% = 33.3% weight in index 60% Company C = 30% = 50% weight in index 60%
 For the value weighted index, we used earnings yield as a measure of value or cheapness. Earnings yield for the entire universe of companies equaled 60% , so Company B, with 20% earnings yield, receives a weight of 33.3% in this traditional value weighted index. Traditional value weighted indexes  can also be based on Book value/ Price, Dividend yield, etc. Notice that market capitalization (and therefore market price) is not considered for this value weighted index.

You could create your own value weighted index for the largest 100 stocks, Dow, S&P 500, Straits Times Index, BSE Sensex, FTSE100, S&P CNX Nifty index as well.

You can sell all the stocks after a year and buy a new value weighted index the next year.

Advertisements