How to create a simple “magic formula investing” type value weighted index

Let us do this using earnings yield and ROA or ROIC

How to Calculate

ASSUME THE STOCK MARKET HAS ONLY THREE COMPANIES:
Earnings yield Return on assets
Company A = 5% 15%
Company B = 10% 10%
Company C = 15% 5%
Total earnings yield
of All Companies
30% Total ROA
of All Companies
30%
EARNINGS YIELD WEIGHTING
Company A = 5% = 16.7% weight in index
30%
Company B = 10% = 33.3% weight in index
30%
Company C = 15% = 50 % weight in index
30%
ROA WEIGHTING
Company A = 15% = 50% weight in index
30%
Company B = 10% = 33.3% weight in index
30%
Company C = 5% = 16.7 % weight in index
30%
COMBINED WEIGHTING= AVERAGE OF ROA WEIGHTING AND EARNINGS YIELD WEIGHTING

Company A= 50%+16.7%/2=33.335%

Company B= 33.3%+ 33.3%/2= 33.3%

Company C= 16.7%+50%/2=33.335%

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.

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