What is the S&P 500 Index?
The S&P 500 Index, or Standard & Poor’s 500 Index, is a market capitalization-weighted index of 500 leading publicly traded companies in the US It is not an exact list of the top 500 US companies. By market capitalization because there are other criteria to be included in the index. The index is considered one of the best indicators of large-cap US equities. Another common benchmark of the US stock market is the Dow Jones Industrial Average (DJIA).
- The S&P 500 index includes 500 leading companies on the US stock market, with a primary emphasis on market capitalization.
- The S&P is a float-weighted index, which means that the market capitalizations of the companies in the index are adjusted by the number of shares available for public trading.
- Because it is widely considered the best indicator of large-cap US stocks, many funds are designed to track the performance of the S&P.
Standard And Poor’s 500 Index
Weighting Formula and Calculation for the S&P 500
The S&P 500 uses a market capitalization weighting method, which gives a higher percentage allocation to companies with the largest market capitalizations.
Weighting of the company in S&P=Total of all market capitalizationsMarket capitalization of the company
Determining the weight of each component of the S&P 500 begins with adding the total market capitalization of the index by adding the market capitalization of each company in the index.
To review, a company’s market capitalization is calculated by taking the current share price and multiplying it by the company’s outstanding shares. Fortunately, the total market capitalization for the S&P, as well as the market capitalizations of individual companies, is frequently published on financial websites, sparing investors the need to calculate them.
The weight of each company in the index is calculated by taking the market capitalization of the company and dividing it by the total market capitalization of the index.
Construction of the S&P 500 Index
The S&P only uses free-floating stocks when calculating market capitalization – that is, stocks that the public can trade. The S&P adjusts the market capitalization of each company to compensate for new equity issues or company mergers. The value of the index is calculated by adding the adjusted market limits of each company and dividing the result by a divisor. Unfortunately, the splitter is proprietary information of S&P and is not disclosed to the public.
However, we can calculate the weight of a company in the index, which can provide investors with valuable information. If a stock goes up or down, we can get an idea of whether it could have an impact on the overall index. For example, a company with a 10% weight will have a greater impact on the value of the index than a company with a 2% weight.
The S&P 500 is one of the most highly traded US indices because it represents the largest publicly traded corporations in the US The S&P 500 focuses on the large cap sector of the US market and is also a float-weighted index (a type of capitalization weighting), which means that the company’s market capitalizations are adjusted by the number of shares available for public trading.
The most recent rebalancing of the S&P 500 was announced on September 3, 2021 and went into effect before the markets opened on September 20, 2021. Match Group Inc. (MTCH) replaced Perrigo Company plc (PRGO) in the index . (Match was previously owned by InterActive Corp, (IAC), which is the parent company of Investopedia.) The S&P MidCap 400 components Ceridian HCM Holding Inc. (CDAY) and Brown & Brown Inc. (BRO) were moved to the S&P 500, replacing Unum Group (UNM) and NOV Inc. (NOV).
S&P 500 vs. DJIA
The S&P 500 is often the index of choice for institutional investors given its depth and breadth, while the Dow Jones Industrial Average (DJIA) has historically been associated with the retail investor indicator of the US stock market. Institutional institutions perceive the S&P 500 as more representative of the US equity markets because it comprises more stocks in all sectors (500 vs. 30 for the Dow).
In addition, the S&P 500 uses a market capitalization weighting method, which gives a higher percentage allocation to companies with the largest market capitalizations, while the DJIA is a price-weighted index that gives companies with prices of higher stocks a higher index weight. Market capitalization weighted structure tends to be more common than price weighted in US indices.
S&P Indices vs. Russell
The S&P 500 is a member of a set of indices created by Standard & Poor’s. The Standard & Poor’s set of indices is like the Russell family of indices in that they are both market capitalization-weighted indices (unless otherwise noted, as equally weighted indices).
However, there are two major differences between the construction of the S&P and Russell families of indices. First, Standard & Poor’s chooses the constituent companies through a committee, while the Russell indices use a formula to choose the stocks to include. Second, there is no name overlap within the S&P style indices (growth versus value), whereas the Russell indices will include the same company in the “value” and “growth” style indices.
Other S&P indices
The S&P 500 is a member of the S&P Global 1200 family of indices. Other popular indices include the S&P MidCap 400, which represents the mid-cap range, and the S&P SmallCap 600, which represents small-cap companies. The S&P 500, S&P MidCap 400, and S&P SmallCap 600 combine to create a US total capitalization index known as the S&P Composite 1500.
S&P 500 vs. Vanguard 500 Fund
The Vanguard 500 Index Fund seeks to track the price and performance of the S&P 500 index by investing its total net assets in the stocks that make up the index and holding each component roughly the same weight as the S&P index. In this way, the fund hardly deviates from the S&P, which it is designed to mimic.
The S&P 500 is an index, but for those who want to invest in the companies that make up the S&P, they should invest in an index-tracking fund like the Vanguard 500 ETF (VOO).
Limitations of the S&P 500 Index
One of the limitations of the S&P and other market capitalization-weighted indices arises when index stocks are overvalued, meaning they rise more than their fundamentals warrant. If a stock is heavily weighted in the index while it is overvalued, the stock generally inflates the overall value or price of the index.
An increasing market capitalization of a company is not necessarily indicative of a company’s fundamentals, but rather reflects the increase in value of shares relative to shares outstanding. As a result, equally weighted indices have become increasingly popular, so movements in the share price of each company have an equal impact on the index.
S&P 500 market capitalization example
To understand how the underlying stocks affect the S&P index, individual market weights must be calculated, which is done by dividing the market capitalization of each company by the total market capitalization of the index. Here is an example of Apple’s weighting in the index:
- Apple Inc. (AAPL) reported 16,530,166,000 basic common shares issued and outstanding as of July 15, 2021, and had a share price of $ 141 as of October 13, 2021.
- Apple’s market capitalization was $ 2.33 trillion (or 16.53 billion x $ 141). The $ 2.33 trillion is used as the numerator in calculating the index.
- The total market capitalization of the S&P 500 was approximately $ 38.41 trillion, which is the sum of the market capitalizations for all stocks in the index.
- Apple’s weight in the index was 6.1%, or $ 2.33 trillion / $ 38.41 trillion).
In general, the greater the market weight of a company, the more impact each 1% change in the price of a share will have on the index. Note that the S&P does not currently provide the total list of the 500 companies on its website, outside of the top 10.