S&P 500 Index: What It’s for and Why It’s Important in Investing

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 U.S. 

It is not an exact list of the top 500 U.S. companies by market cap because there are other criteria that the index includes. Still, the S&P 500 index is regarded as one of the best gauges of prominent American equities' performance, and by extension, that of the stock market overall.

Key Takeaways

  • The S&P 500 Index features 500 leading U.S. publicly traded companies, with a primary emphasis on market capitalization.
  • The S&P 500 Index was launched in 1957 by the credit rating agency Standard and Poor's.
  • The S&P is a float-weighted index, meaning the market capitalizations of the companies in the index are adjusted by the number of shares available for public trading.
  • Because of its depth and diversity, the S&P 500 is widely considered one of the best gauges of large U.S. stocks, and even the entire equities market.
  • You can't directly invest in the S&P 500 because it's an index, but you can invest in one of the many funds that use it as a benchmark, tracking its composition and performance.

Standard And Poor's 500 Index

Weighting Formula and Calculation of the S&P 500

The S&P 500 uses a market-cap weighting method, giving a higher percentage allocation to companies with the largest market capitalizations.

Company Weighting in S & P = Company market cap Total of all market caps \text{Company Weighting in S \& P}= \frac{\text{Company market cap}}{\text{Total of all market caps}} Company Weighting in S & P=Total of all market capsCompany market cap

Determining the weighting of each component of the S&P 500 begins with adding up the total market cap for the index by adding together the market cap of every company in the index.

To review, the market cap of a company is calculated by taking the current stock price and multiplying it by the company's outstanding shares. Fortunately, the total market cap for the S&P 500 as well as the market caps of individual companies are published frequently on financial websites, saving investors the need to calculate them.

The weighting of each company in the index is calculated by taking the company's market cap and dividing it by the total market cap of the index.

Other S&P Indices

The S&P 500 is a part of the S&P Global 1200 family of indices. Other indices included are the S&P MidCap 400, which represents the mid-cap range of companies, 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 cover 90% of all U.S. capitalization in an index known as the S&P Composite 1500.

S&P 500 Index Construction

The S&P only uses free-floating shares when calculating market cap, meaning the shares that the public can trade. The S&P adjusts each company's market cap to compensate for new share issues or company mergers. The value of the index is calculated by totaling the adjusted market caps of each company and dividing the result by a divisor. The divisor is proprietary information of the S&P and is not released to the public.

However, you can calculate a company's weighting in the index, which can provide investors with valuable information. If a stock rises or falls, you can get a sense as to whether it might have an impact on the overall index. For example, a company with a 10% weighting will have a greater impact on the value of the index than a company with a 2% weighting.

The S&P 500 is one of the most widely quoted American indexes because it represents the largest publicly traded corporations in the U.S. The S&P 500 focuses on the U.S. market's large-cap sector and is also a float-weighted index (a type of capitalization weighting), meaning company market caps are adjusted by the number of shares available for public trading.

The S&P 500's most recent rebalancing was announced on March 10, 2023, and took effect before markets opened on March 15, 2023. SVB Financial Group was removed from the S&P 500 Index due to the failure of its bank, Silicon Valley Bank. The Federal Deposit Corporation (FDIC) took the group into receivership, making it ineligible for inclusion into the index. It was replaced with Insulet Corp. Similarly, on the same date, Signature Bank was taken into FDIC Receivership and was removed from the index and replaced with Bunge Ltd.

S&P 500 Competitors

S&P 500 vs. DJIA

Another common U.S. stock market benchmark is the Dow Jones Industrial Average (DJIA). The S&P 500 is often the institutional investor's preferred index given its depth and breadth, while the DJIA has historically been associated with significant equities from the retail investor's point of view. Institutional investors perceive the S&P 500 as more representative of U.S. equity markets because it comprises more stocks across all sectors (500 versus the Dow's 30).

Furthermore, the S&P 500 uses a market-cap weighting method, giving a higher percentage allocation to companies with the largest market caps, while the DJIA is a price-weighted index that gives companies with higher stock prices a higher index weighting. The market-cap-weighted structure tends to be more common than the price-weighted across U.S. indexes.

S&P 500 vs. Nasdaq

Nasdaq is a global electronic marketplace for trading securities. There are several equity market indexes that include stocks traded on Nasdaq. Note that a given stock included in the S&P 500 Index may also be in one or more of the various Nasdaq indexes.

Among the most-watched Nasdaq stock indices are: The Nasdaq 100 Index, which includes 100 of the largest, most actively traded common equities listed on Nasdaq; the Nasdaq Composite Index, which the media often simply refers to as "the Nasdaq" (and which includes more than 2,500 common stocks that trade on Nasdaq); the Nasdaq Global Equity Index (NQGI), which includes international stocks; and the PHLX Semiconductor Sector Index (SOX), which is the leading barometer of stocks related to the semiconductor industry; the OMX Stockholm 30 Index (OMXS30), which includes 30 actively traded stocks on the Stockholm Stock Exchange.

S&P 500 vs. Russell Indexes

The S&P 500 is a member of a set of indexes created by Standard & Poor's. The Standard & Poor's set of indexes is like the Russell index family in that both are market-cap-weighted indexes unless stated otherwise (as in the case of equal-weighted indexes, for example).

However, there are two large differences between the construction of the S&P and Russell families of indexes. First, Standard & Poor's chooses constituent companies via a committee, while Russell indexes use a formula to choose stocks to include. Second, there is no name overlap within S&P style indices (growth versus value), while Russell indexes will include the same company in both the "value" and "growth" style indexes.

S&P 500 vs. Vanguard 500 Fund

The Vanguard 500 Index Fund seeks to track the price and yield performance of the S&P 500 Index by investing its total net assets in the stocks comprising the index and holding each component with approximately the same weight as the S&P index. In this way, the fund barely deviates from the S&P, which it is designed to mimic.

The S&P 500 is an index, so it can't be traded directly. Those who want to invest in the companies that comprise the S&P must invest in a mutual fund or exchange-traded fund (ETF) that tracks the index, such as the Vanguard 500 ETF (VOO).

Limitations of the S&P 500 Index

One of the limitations of the S&P and other market-cap-weighted indexes arises when stocks in the index become overvalued, meaning they rise higher than their fundamentals warrant. If a stock has a heavy weighting in the index while being overvalued, the stock typically inflates the overall value or price of the index.

A company's rising market cap isn't necessarily indicative of a company's fundamentals so much as it reflects the stock's increase in value relative to shares outstanding. As a result, equal-weighted indexes have become increasingly popular whereby each company's stock price movements have an equal impact on the index.

Example of the S&P 500 Market Cap Weighting

In order to understand how the underlying stocks affect the S&P index, the individual market weights must be calculated by dividing the market cap of each company by the total market cap of the index. Below is an example of Apple's weighting in the index:

  • Apple Inc. (AAPL) reported 15.94 billion shares outstanding in their Feb. 2023 annual filing for the quarter ending Dec. 31, 2022, and had a stock price of $157.40 as of March 20, 2023.
  • Apple's market cap is $2.49 trillion (approximately 15.94 billion x $157.40) as of March 20, 2023. The $2.49 trillion is used as the numerator in the index calculation.
  • The S&P 500 total market cap is approximately $35.00 trillion as of Feb. 28, 2023, which is the sum of the market caps for all of the stocks in the index.
  • Apple's weighting in the index was approximately 7.11%, or $2.49 trillion divided by $35.00 trillion.

Overall, the larger the market weight of a company, the more impact each 1% change in a stock's price will have on the index. Note that S&P does not currently provide the total list of all 500 companies on its website, outside of the top 10.

Why Is It Called Standard and Poor's?

The first S&P Index was launched in 1923 as a joint project by the Standard Statistical Bureau and Poor's Publishing. The original index covered 233 companies in 26 different industries. The two companies merged in 1941 to become Standard and Poor's.

Who Qualifies for the S&P 500?

In order to be included in the S&P 500 Index, a company must be publicly traded and based in the United States. It also needs to meet certain requirements for liquidity and market capitalization, have a public float of at least 10% of its shares, and have positive earnings over the trailing four quarters.

How Do You Invest in the S&P 500?

The simplest way to invest in the S&P 500 Index (or any other stock market index) is to buy shares of an index fund that targets that index. These funds invest in a cross-section of the companies represented on the index, meaning that the fund's performance should mirror the performance of the index itself.

The Bottom Line

The S&P 500 Index is one of the most widely-used indexes for the U.S. stock market. These 500 companies represent the largest and most liquid companies in the U.S., from technology and software companies to banks and manufacturers. Although the index is created by a private company, the S&P 500 is now a popular yardstick for the performance of the market economy at large.

Article Sources
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