What Is a Constituent?
A constituent is a company with shares that are part of an index like the S&P 500 or Dow Jones Industrial Average. It is a component or a member of the index. The aggregate of the shares of all constituents are used to calculate the value of the index.
Individual constituents make up the market indexes in the United States, including the Dow Jones Industrial Average, the S&P 500, the Nasdaq Composite Index and the NYSE Composite Index, The Dow Jones Industrial Average, for example, consists of shares of thirty large companies. It dates back to 1896. However, Charles Dow created the first index—at that time, it was a simple average of stock prices—in 1884 when he published the Dow Jones Railroad Average, which is today known as the Dow Jones Transportation Average.
Indexes serve a number of important functions, including tracking the performance of particular markets or sectors of the stock market or economy and providing investors and portfolio managers with benchmarks to evaluate their own performance. For investors in the stock market, the S&P 500 Index is considered the benchmark for relative performance and a fund manager that consistently outperforms the index is "beating the market."
By gaining entrance into a market index, a constituent stock or company receives the benefit of increased exposure and a certain amount of credibility. It can also boost the share price because there are many passive index funds that attempt to track the S&P 500 and other indexes. When a company becomes a constituent, these funds must buy shares and the buying demand can create an S&P 500 phenomenon called the index effect.
- A constituent is a member or component of an index or average like the Dow, S&P 500, or Nasdaq.
- Companies must meet certain requirements, which are determined by the publishers of the index, before being added to an index.
- The value of an index is based on mathematical formulas that consider the share prices of all constituents within the index.
- Indexes are useful for tracking the performance of specific markets and sectors.
Requirements of Constituents
Criteria for being a constituent of a market index vary from one index to another. The Dow Jones Industrial Average is comprised of well-known companies, spanning across many industries, with each constituent having a weight on the overall index proportional to its price. A committee at Dow Jones determines who comes and goes within the industrial average.
While the Dow is a price-weighted index, other indexes are sometimes created differently. There are three general methods for building an index:
- Price-weighted indexes give greater weight to the share price of each constituent.
- Market value-weighted indexes give more weight to the size or market capitalization of each constituent.
- Equal-weighted indexes treat all members the same, without regard to price or market cap.
The Nasdaq Composite Index and New York Composite Index track the performance of all equities listed on each stock exchange. The weight that each individual constituent has on the overall index is based on market capitalization, with both the price return and dividend yield of each constituent factoring into movements of the index. The S&P 500 is another example of a market value-weighted index and the largest companies have the biggest impact on its performance.