Stock indexes are formed based on the kinds of stocks or financial securities they want to track. For example, the Standard & Poor's 500 (S&P 500) index tracks large cap stocks, while the Dow Jones Industrial Average (DJIA) tracks large cap industrial stocks. For a stock to be added to an index, it must meet a list of guidelines. Depending upon the scope of the index, each index will have its own requirements for component eligibility. For example, the Wall Street Journal maintains the DJIA and one requirement is that the stock be "of interest to a large number of investors". In addition, two common requirements for component selection are that the stock must be relevant to the scope of the index and that the stock must meet all Securities and Exchange Commission (SEC) rules.

If the stock does not adhere to the requirements set out by the organization maintaining the index, the stock will not be added. For example, the S&P 500 will not add a stock that does not meet its large cap requirements. Similarly, if a company is an existing component of the index, but a material change to the company has occurred, it will get pulled from the index. Further, a component company will be removed if it has been acquired and no longer is traded publicly. The indexes also make sure that the companies they add meet all SEC guidelines. If a company violates a SEC rule or is known to have defrauded investors, that company's stock is pulled from the index. In other words, for a company to be added to an index, the company's stock has to be relevant to the purpose of the index and the company must be in full compliance with securities regulations. (To learn more about indexes, see Index Investing and Is it possible to invest in an index?)

This question was answered by Chizoba Morah

  1. Is a financial advisor allowed to pay a referral fee?

    A financial advisor is allowed to pay a referral fee to a third party for soliciting clients. However, the Securities and ... Read Full Answer >>
  2. How often do mutual funds report their holdings?

    The Securities and Exchange Commission (SEC) requires mutual funds to report complete lists of their holdings on a quarterly ... Read Full Answer >>
  3. Do financial advisors need to be approved by FINRA?

    The term "financial advisor" can refer to a couple of different roles. It most often refers to a broker-dealer or an investment ... Read Full Answer >>
  4. What are the disclosure requirements for a private placement?

    The U.S. Securities and Exchange Commission (SEC) has set forth disclosure requirements for private placements, including ... Read Full Answer >>
  5. What role does the Inspector General play with the Securities and Exchange Commission?

    The inspector general of the U.S. Securities and Exchange Commission (SEC) oversees, audits and conducts investigations of ... Read Full Answer >>
  6. How long does it take to execute an M&A deal?

    Even the simplest merger and acquisition (M&A) deals are challenging. It takes a lot for two previously independent enterprises ... Read Full Answer >>
Related Articles
  1. Economics

    The 5 Countries That Produce the Most Carbon Dioxide (CO2)

    Learn about the top five countries, China, the United States, India, Russia and Japan, that are the largest contributors to carbon dioxide emissions.
  2. Investing Basics

    Explaining the 10-K

    A 10-K is an annual comprehensive report that thoroughly recaps a company’s performance.
  3. Economics

    Explaining the Tier 1 Leverage Ratio

    The Tier 1 leverage ratio measures a bank’s core capital against its total assets.
  4. Investing Basics

    What Is Schedule 13G Used For?

    Schedule 13G is an SEC form an investor must file upon taking ownership of 5% or more of a company’s outstanding shares.
  5. Investing News

    Understand the SEC Rules on Equity Crowdfunding

    The SEC's adoption of equity crowdfunding rules, initiated under the JOBS Act, enables small investors to invest in companies that show early potential.
  6. Insurance

    Airbnb Insurance: Will It Cover Enough?

    If a paying guest trips over a rug in your home, breaks an ankle and sues for damages, here's how to make sure your coverage protects you.
  7. Insurance

    5 (Possibly) Costly Risks of Being an Airbnb Host

    Guests who get injured or damage your neighbor’s property are just a couple of examples of what can go wrong. Here’s how to protect yourself.
  8. Investing News

    Mexican Energy, Telecom Reforms Please Foreign Investors

    Two years into his first term, Mexican President Enrique Peña Nieto is following through on radical campaign promises he made to Mexican citizens for sweeping multi-industry reform.
  9. Investing

    Top Cities Where Airbnb Is Legal Or Illegal

    Thinking of subletting your apartment on Airbnb? Make sure that you meet your city's regulations first.
  10. Term

    Understanding the Maintenance Margin

    A maintenance margin is the minimum amount of equity that must be kept in a margin account.
  1. Maintenance Margin

    The minimum amount of equity that must be maintained in a margin ...
  2. Emergency Banking Act Of 1933

    A bill passed during the administration of former U.S. President ...
  3. Slander

    Slander is the act of harming one person’s reputation by telling ...
  4. Libel

    Libel is publishing a statement about someone in written form ...
  5. Defamation

    Defamation is any statement (written or spoken) that damages ...
  6. Fair Housing Act

    This law (Title VIII of the Civil Rights Act of 1968) forbids ...

You May Also Like

Hot Definitions
  1. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  2. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  3. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  4. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  5. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  6. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!