Business, Legal & Accounting Glossary
An arithmetic average that takes into account the importance of the items making up the average.
The weighted average (weighted mean) is an arithmetic average that takes into account the importance of the items making up the average.
In calculating the value of a share index, the share prices are typically weighted in some way; most frequently by the market capitalisation of the company.
A weighted average is an average that adjusts for the frequency of individual values. Here’s an example of a weighted average: suppose 20 people are asked to estimate the number of goats Farmer Jones has. One says 4; seven, 5; eleven, 6; and one, 30. To find the weighted average, multiply each value (ie, number of goats) by the number of people who made that estimate, add up the results, and then divide by the number of people. Thus the weighted average is [(1×4)+(7×5)+(11×6)+(1×30)]/(20)= 6.75. In a weighted average, values that are unusual have relatively little effect. In the example, the weighted average was raised relatively little by a very high estimate of 30 goats, because only one person made that guess. A weighted average is used frequently in business and investing. Consensus earnings estimates by analysts, for example, are usually computed by weighted average. The weighted average cost of capital, while more complex than our simple example would indicate, also involves using a weighted average.
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This glossary post was last updated: 5th February, 2020