Capitalization Weighted Indexes

Dec 2002 //

In past client letters I’ve tried to shed some light on a number of economic and investment misperceptions.  One persistent problem, as I see it, is investors’ tendency to regard the Dow Jones Industrials or the S&P 500 as “the market.”  While many investors understand that there are only 30 stocks in the Dow, the 500 stocks in the S&P 500 seem to give it a flavor of much broader market representation.  However, the S&P 500 is capitalization weighted, which means that each stock in this index has a weight equal to the stock’s capitalization (number of shares times the price per share) expressed as a percent of the total capitalization of all 500 companies.  In addition to the S&P 500, a number of popular indexes, including the Nasdaq Composite and the Nasdaq 100, are also capitalization weighted.  (The Nasdaq 100 is simply an index of the 100 largest companies traded on Nasdaq.)  Given that the Nasdaq 100 companies represent the overwhelming majority of the market capitalization of all Nasdaq companies, the Nasdaq Composite and the Nasdaq 100 track exceedingly closely.  The degree of concentration in the Nasdaq 100’s weighting is much greater than most investors would guess.