In its simplest form, a price weighted average is just the average price of a group of stocks. It's considered "price weighted" because the same percent increase in a higher priced stock influences the average more than that of a lower priced stock. Computing the price weighted average is complicated by stock splits. As an example, if a $30 stock splits into two $15 stocks, the company hasn't lost value, so it would no longer be appropriate to use a simple average with $15 as the stock's price. To compensate for splits, the formula's divisor changes, even if the number of stocks in the average has not.
Price Weighted Average
1. Reference each stock's closing price for the same day. As an example, say you wanted to compute the price weighted average of just two stocks: Stock ABC closed at $20, and stock XYZ closed at $60.
2. Add each stock price. In the example add $60 and $20 to get $80.
3. Divide by the divisor. The first time you compute the price weighted average, the divisor is simply the number of stocks, but this value may change with stock splits. In the example, dividing $80 by 2 gives a price weighted average of $40, but stock splits will change this calculation.
Adjusting the Divisor for Stock Splits
1. Divide the closing price of the split stock on the day immediately prior to the split by the split number. In the example, if stock XYZ incurred a 2-for-1 split the day after you computed your average, you would divide $60 by 2 to get a split price of $30.
2. Add this new price to the other stock prices. In the example, $30 plus $20 gives you a new numerator of $50.
3. Divide this value by the price weighted average, computed on the day immediately prior to the stock split. In the example, $50 divided by $40 gives you a new divisor of 1.25. Use this new divisor in the price weighted calculation until another one of the indexed stocks split, at which time you need to repeat the calculation to derive an updated divisor.
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