Lesson 4 of 7 · 14 min
Market-cap, float-adjusted and fundamental weighting
Market-cap weighting holds each stock in proportion to its market value, ideally counting only freely tradable shares; fundamental weighting uses size measures that ignore price, which tilts the index towards value stocks and works against momentum.
In short
- Market-cap (value) weighting: weight = shares outstanding × price ÷ total market cap of all constituents.
- Float-adjusted market-cap weighting counts only the market float: shares available to the investing public (excluding controlling holders, other companies, governments and, for some global indexes, shares closed to foreigners). Most cap-weighted indexes today are float adjusted.
- Advantage: securities are held in proportion to their value in the target market. Disadvantage: stocks that have risen most get the biggest weights, a momentum effect that overweights possibly overvalued stocks.
- Fundamental weighting uses size measures independent of price (book value, cash flow, revenue, earnings, dividends, employees), alone or as a composite.
- Fundamental indexes have a value tilt and a contrarian effect at rebalancing: stocks with high earnings (book, dividend) yields get more weight than under cap weighting.
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