Price Weighting
Price weighting is an index method in which each stock's influence depends on its share price rather than on the size of the company.
In a price-weighted index, stocks with higher share prices have more influence than stocks with lower prices. The index is calculated by adding up the share prices of all members and dividing by a divisor. The best-known examples are the Dow Jones Industrial Average and Japan's Nikkei 225.
The method is simple and dates back to the early days of index calculation, when computing was done by hand. Its weakness is that share price says little about a company's size or economic importance. A small company with a high share price can affect the index more than a much larger company with a low share price.
Stock splits illustrate the issue. When a member splits its stock, its price drops and its weight in the index falls, even though nothing about the company has changed. The divisor is adjusted so the index value does not jump, but the company's future influence is smaller.
Example: an index contains two stocks priced at $300 and $30. A 10% rise in the $300 stock adds $30 to the price sum, while a 10% rise in the $30 stock adds only $3, even if the second company is much larger by market value.