What it means
Most famous stock indexes weight companies by their size, so a handful of giants drive the result. The Value Line Index takes a different approach, giving each of the many companies it follows an equal say regardless of market capitalisation, which is the total market value of a company's shares.
The index comes in two main versions, arithmetic and geometric. The arithmetic version averages the price moves of the member companies, while the geometric version multiplies them together and takes a root, which is the method that dampens the effect of extreme winners.
Because small and mid-sized companies make up most of its members, the index often behaves differently from size-weighted benchmarks. In years when smaller companies do well, it tends to look strong, and when the biggest companies lead the market, it tends to lag.
That difference is the main reason professionals look at it alongside the headline benchmarks. Investors and analysts use it to judge the breadth of a market move.
If the large-company indexes rise while the Value Line Index is flat, the gains are concentrated in a few names and the average stock is not taking part. The reverse pattern suggests a broad rally.
A nuance is that the geometric version will usually show a lower return than the arithmetic version over the same period. This is a mathematical feature of averages, not a sign that either is wrong, so be sure to compare like with like.
In practice
Real-world examples.
Example
A fund manager sees the large-company index up 12% but the Value Line Index up only 3%. She concludes that a few big names are driving the market and that the average share has barely moved. She trims her exposure to the largest shares and adds some mid-sized companies to spread the risk.
Example
A financial adviser explains to a client why an equal-weighted fund tracked the Value Line Index rather than a size-weighted benchmark. In a year when smaller companies surged, the client's fund outperformed the big-company index. The adviser notes that the pattern can reverse, so past outperformance is no promise of future results.
Example
A university finance class uses the index to show how weighting changes results. Students compare equal-weighted and size-weighted returns for the same five companies. The class sees that the weighting method alone can shift the headline figure by several percentage points.
Formula
Calculation
Arithmetic index change = Average of the price relatives (ending price / starting price) of all members
Geometric index change = nth root of the product of the price relatives
Take a simplified two-company index that starts at 1,000. Company A rises from $50 to $100, a price relative of 2.0, and Company B falls from $80 to $40, a price relative of 0.5. The arithmetic average is (2.0 + 0.5) / 2 = 1.25, so the arithmetic index moves to 1,000 x 1.25 = 1,250. The geometric measure is the square root of (2.0 x 0.5) = the square root of 1.0 = 1.0, so the geometric index stays at 1,000. The published indexes cover many more companies, but the principle is the same.Case study
Seen in the real world.
This illustrative story is about a fictional investment club, the Meridian Savers Circle, whose members compared their portfolio with a big-company index each year. For three years in a row they were behind the benchmark and began to lose faith in their stock picking.
The club treasurer suggested comparing them with the Value Line Index instead, since the club mainly owned small and mid-sized companies. Against that equal-weighted measure, the club was ahead by about two percentage points a year.
The members concluded that the benchmark had been the wrong yardstick, not the strategy. They agreed to track both measures every quarter, and to treat the gap between them as a sign of how narrow or broad the market was. The club and its figures are fictional, but the lesson about choosing a benchmark that matches what you actually own is a real one.
Watch out
Common mistakes.
- Comparing a small-company portfolio with a size-weighted index. The benchmark should reflect the type of companies actually held.
- Assuming the arithmetic and geometric versions will match. The geometric version normally shows a lower return, because of how averages work.
- Thinking an index can be bought directly. An index is only a measurement, and investors need a fund or product that tracks it.
Questions
People also ask.
Why does equal weighting matter?
It stops the largest companies from dominating, so the index reflects the experience of the average company rather than the biggest ones.
Who publishes the index?
Value Line, the investment research firm behind the Value Line Investment Survey, compiles it.
Is the index price only or does it include dividends?
The published index is generally based on price moves, so dividends are not included unless a total return version is stated.
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