The stocks listed on an index are subject to change over time due to factors such as market capitalisation and mergers and acquisitions. Here we describe these factors in a little more detail.
Many indices value a company in terms of market capitalization rather than sales or total asset figures. A company’s market capitalization is the total market value of its issued shares. This is calculated by multiplying the number of issued shares of a company with the current market price of one share.
Because the total market capitalization of an index is affected by the individual share prices of the companies, as share prices fluctuate, an index’s value will change too. For example, as mentioned above, the FTSE 100 index represents an average of the share prices of the top 100 publicly traded companies on the London Stock Exchange. To ensure that the FTSE 100 reflects these top 100 companies, it is revised quarterly, in March, June, September and December. This makes the component stocks of an index subject to change over time.
For example, if a company’s market capitalization plummets, its stocks may become too small to remain on the index that it is listed on. The company would then be demoted from that index, being replaced with a company with a higher market capitalization.
The stocks listed on an index can also change when mergers occur. When two businesses combine to form a new company, the stocks representing each company combine to form one tradable entity. An example of this is the merger of the UK companies, Dixons and Carphone Warehouse in 2014. The two previously separate stocks merged into Dixons Carphone.
For more information on trading indices, it is worthwhile reading our ‘What are Indices?’ and ‘How to Trade Indices’ pages. To start trading on indices, sign up for an account, or register for a demo account to start practicing today.