An index divisor represents the denominator in a sometimes technical or complex stock formula. Many national stock indexes use a divisor to compute the total value reported for a group of stocks. For example, the Dow Jones Industrial Average (DJIA) in the United States takes the value of each company in the Dow and divides it by the DJIA index divisor, which is a constantly changing divisor. The divisor changes for different purposes; making small adjustments at times allows stakeholders to have comparable information over time for a stock index. This divisor may not have a large amount of mathematical theory behind it.
A price-weighted index is often a popular type that uses an index divisor. The purpose of changing the denominator in this calculation allows individuals to reassess the entire index when a company in the index issues more stock. When this occurs, any additional stock offering carries a title such as a secondary or third offering. Companies offer more stock in future periods after the initial public offering due to increased demand — most likely — a higher need for capital to run the business. In order for the price-weighted index to offer similar data in a trend, the index divisor must change as well.
While additional stock offerings change the index divisor in a price-weighted index — and most other stock indexes — other items related to the stock will not. For example, dividends issued from a company that has stock in the index do not typically change the divisor. Additionally, stock dividends or stock splits also may not change the divisor used to compute the price-weighted index figure. These changes do not affect the price-weighted index as new investors do not get added to the mix. Only those investors who already own company stock are affected, making the changes much less important than an additional stock offering.
Other instances of changes to a stock divisor are possible, with little mathematical rationale behind the changes. For example, an index divisor might change when a company makes changes or alterations to employee stock option plans. This eventually releases more stock into the market and changes the value of an entire index in which the company’s stock resides. Additionally, stock repurchases made by a company or employees who sell stocks may also change or alter the stock index. When this occurs, reviewers of the stock index may change the index divisor in order to recompute the total index.
