What is an index divisor?

An index divisor is defined as an arbitrary number chosen when an index is first established. As the name suggests, the divisor is used to divide the index’s total value to obtain an initial index value of a simple number, such as the number ‘100’. This will allow stock market indexes to reflect changes in the bourse’ value accurately.

How does an index divisor work?

An entity creates a new stock market index by choosing the index’s components and then adding up the value of all the components. The results may be a huge number.

For instance, the company is gathering a 20-stock index with the total share prices at 492. To bring an initial value of 100, the company uses a divisor of 4.92. Once the index is launched, the divisor will be used to the new totals to show that the index changes from the first 100 levels.

The index divisor has stayed constant since the index’s launch, except for when securities are added or removed from the index. Depending on the index type, the divisor may need to be altered when component stocks have corporate actions.

In a price-weighted index, the divisor does not need to be adjusted when a component stock launches a secondary offering. However, the divisor needs to be modified when a component stock issues a stock dividend or undergoes a stock split.

The divisor is altered when a component issues new stock through a secondary offering in a market capitalisation-weighted index. However, the divisor does not need an adjustment when a component issues a stock dividend or undergoes a stock split.

Index divisor examples

Dow Jones uses its own Dow Divisor to calculate the Dow Jones Industrial Average (DJIA).

The Dow Divisor is a numerical value used to calculate the DJIA. The DJIA is calculated by adding up all the stock prices of its 30 components and dividing the sum by the divisor. As Dow Jones is a price-weighted index, it adjusts its divisor for corporate actions, such as dividend payments and stock splits.