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%
|ASSUME THE STOCK MARKET HAS ONLY THREE COMPANIES:|
|Company A =||10%|
|Company B =||20%|
|Company C =||30%|
|Total earnings yield
of All Companies
|TRADITIONAL VALUE WEIGHTED INDEX|
|Company A =||10%||= 16.7% weight in index|
|Company B =||20%||= 33.3% weight in index|
|Company C =||30%||= 50% weight in index|
|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.