How are stockmarket indices weighted?

Not all indices are structured according to the same calculation rules. Capitalization, price, equal weighting… The Dow Jones does not work in the same way as European indices. And the DAX cannot really be compared to the CAC 40… Let's try to clarify things.

There are two main types of stockmarket indices: those weighted by market capitalization (CAC 40, DAX, Euro Stoxx, S&P 500, etc.) and those weighted by price (Dow Jones, Nikkei 225).

1/ Market capitalization-weighted indices

The vast majority of stockmarket indices around the world are weighted by free float. This means that each company is weighted according to the proportion of its capital that is actually available for purchase or sale on the markets. Shares held on a long-term basis by stable shareholders such as the state, founders or strategic investors are therefore excluded. The higher a company's free float, the greater its influence on the index's performance. This is why Schneider Electric can weigh over LVMH in the CAC 40, even though its total market capitalization is lower: the former has a free float of over 90%, while the latter is largely controlled by the Arnault family.

No company can represent over 15% of the index. We are currently far from this, as the largest weighting, Schneider Electric, represents 7.4% of the CAC 40.

Euronext has very specific criteria for selecting stocks eligible for the CAC 40. To be eligible, companies must be listed in euros on Euronext Paris, be subject to continuous trading, and if their reference market is foreign, they must demonstrate significant activity in France in terms of assets, employment, or trading volumes of derivative products. Liquidity requirements also apply: a free float turnover rate of at least 20% over 12 months is required for annual reviews, 30% for new entries during quarterly reviews, and 10% for companies already included in the index.

The CAC 40 is reviewed four times a year — in March, June, September, and December — with a more in-depth annual review in September. These updates are based on an analysis of data collected approximately one month before the review date. Companies are ranked according to two combined criteria: free float and total stockmarket value over 12 months.

At the end of this ranking, the top 35 companies are selected to make up the CAC 40. However, to avoid frequent changes, a buffer zone ranging from 36th to 45th place allows companies that are already members of the index to remain even if they have fallen slightly outside the top 35.

Finally, even though the process is highly regulated, the Scientific Council for the indices retains a margin of intervention. It may adjust the final composition if this ensures better sector representation (for example, to avoid over-representation of a particular sector), index stability or better liquidity for investors who replicate it.

However, there are a few subtleties within capitalization-weighted indices. For example, the German DAX is an index that includes the distribution of dividends by the companies that comprise it. Therefore, to have a reasonable basis for comparison, it must be compared to the CAC 40 with dividends reinvested. Below is the performance of the DAX compared with the CAC 40 dividends reinvested and the CAC 40 over a 10-year period.

2/ Price-weighted indices

These indices are rarer. There are only two known indices of this type: the Dow Jones and the Nikkei 225 (Japan). They hark back to a time when capitalization data was not available.

The index works by giving more weight to stocks with the highest unit price. It does not take into account the actual size of the companies concerned. In concrete terms, each stock influences the index in direct proportion to its market price: a stock priced at $500 will have five times more impact than a stock priced at $100, even if the latter represents a much larger company. The calculation is based on the arithmetic average of the prices, adjusted using a divisor – the Dow Divisor – which takes into account splits and other technical operations. In the Dow Jones, the main weightings are, in order, Goldman Sachs, Microsoft, Home Depot, Visa, Sherwin-Williams, Caterpillar, McDonald's, UnitedHealth, American Express, and Amgen.

3/ New forms of indices

In recent years, new forms of indices have emerged, used in particular in passive management and thematic ETFs. Among these, equally weighted indices offer a simple approach: each security has the same weight. This dilutes the influence of very large capitalizations and provides a more balanced view of overall performance. This is the case with the S&P 500 Equal Weight, where all companies, large and small, count equally. Alongside this, other so-called "smart beta" indices are constructed on fundamental criteria such as earnings, dividends, cash flows, volatility and ESG criteria. The idea here is to weight stocks according to their financial or non-financial qualities, rather than their market weight. These indices, such as the MSCI World Minimum Volatility Index or the FTSE High Dividend Yield Index, allow certain characteristics deemed more interesting according to the investor's profile to be filtered out.