What is the S&P 500 Index?
The S&P 500 Index is a stock market indicator that measures the health of the U.S. securities market. It tracks the performance of stocks of the 500 largest exchange-traded companies in the U.S.
S&P 500 stands for Standard & Poor’s 500, a joint venture of S&P and Dow Jones Indices. It is the statistical measure that is useful for evaluating an investor portfolio. S&P index is an investment benchmark to gauge the overall performance of the US stock markets. It is an economic indicator to screen the health of the American economy.
Which companies are included in Standard & Poor’s 500?
The S&P 500 Index includes around 505 stocks from top companies. The committee hand-picks each company based on its size and liquidity.
These companies belong to one of the following 11 sectors:
- Information Technology
- Consumer Discretionary
- Communication Services
- Consumer staples
- Real Estate
The companies are then indexed on the ‘constituent list’ based on their capitalization. Each company must qualify against the specified eligibility criteria. It ensures only the most stable companies are a part of the list. To maintain its relevance, the committee reviews and updates the list every quarter.
Eligibility criteria for companies to be listed on Standard & Poor’s 500
A company must fulfill the following eligibility criteria to qualify for the Standard & Poor’s 500 Index-
1. It must be based in the United States and listed on an eligible exchange. New York Stock Exchange (NYSE), Investors Exchange (IEX), Nasdaq, Real Estate Investment Trust (REIT), and BATS Global Markets are eligible.
2. Its unadjusted market cap, i.e., the total value of its outstanding shares, must be at least $8.2 billion.
3. At least 50% of the company stock must be available to the public and priced at least $1 per share.
4. It must file an annual 10-K report with full details of its financial performance.
5. At least 50% of fixed assets and revenues of the company must be in the U.S.
6. It should have four consecutive quarters of positive earnings.
The formula for S&P 500 Index
The formula for S&P 500 index is based on market capitalization. Companies with large market capitalization have higher percentage allocations. To calculate the market value of a company, multiply its current stock price with the total number of its shares held by all investors.
The committee uses a base-weighted aggregate methodology for company weighting in S&P. The market cap of a company to be indexed is divided by the total market capitalization of all companies to arrive at a ‘composite index’. The index value of the S&P 500 fluctuates on a trading day. This fluctuation is due to changes in the market capitalization of the 500 listed companies and their weightage.
S&P 500 Index Construction for US Stock Market
The S&P 500 Index is weighted by free-floating shares of a company. Unlike market cap calculation, S& P considers only publicly traded shares in its calculations. The Index compensates for the issue of new shares or mergers by adjusting the company’s market cap. The value of the S&P index is calculated by dividing the adjusted market caps of each company with an arbitrary value known as the ‘Index Divisor’. The value of this divisor is not available to the public.
The fluctuations in a company’s share price impact the index’s overall value in proportion to its weighting. So, the rise in the price of a share of a high-weighted company will increase the Index value.
Difference between S&P 500 Index and DJIA
Charles Dow and Edward Jones created an Index in 1896, which is known as Dow Jones. The Dow Jones Industrial Average (DJIA) tracks the performance of 30 large blue-chip public companies. The number of companies on the Index was 12 earlier but they are now 30, therefore the name Dow 30. It comprises stocks traded on the New York Stock Exchange (NYSE) and the NASDAQ.
The difference between S&P 500 index and DJIA is in their weighting method. Market capitalization is the basis of weighting in the S&P 500. While DJIA uses a price-weighted index. As per S&P 500 percentage allocation is higher for companies with a large market cap. But DJIA gives more weightage to the companies with higher stock prices.
Institutional investors prefer the S&P 500 index as it gives them a deeper insight into the market. The S&P 500 covers more stocks from a variety of sectors compared to 30 in DJIA. Retail investors gauge market performance using Dow Jones Industrial Average.