International Investing

The price weighting of the Dow means that a firms that have a high stock price have more influence than firms with a lower stock price. Basically the index price is the sum of the stocks divided by an adjusting factor for splits. This lets a stock with a price of $100 have twice the influence on the price weighed index then a stock work $50, regardless of the size of the firms.

All the news about the DJIA reaching new highs? As many observers have pointed out only 10 of the 30 stocks are above their January 2000 highs. If a market cap weighting was used to calculate the index the return would have been ~1%. Meaning the Dow’s daily “new highs” are a lucky accident – not indicative of a trend.

Market cap weighting is a smarter way to go. The new trend is fundamental weighting – based on dividends or net income – back testing shows these concepts work.

A unique take on fundamental weighting is by using patents. Ocean Tomo Patent 300 ETF which picks equities on this basis and according to thestreet.com:

Over the last 10 years, the patent weighting has averaged 3 percentage-point better returns annually over the S&P 500, with a 92% correlation to the index. The methodology assesses the economic value of a company’s patent portfolio, then assigns a score to that portfolio and ranks it with other companies.