What Is the S&P 500 Index?

The S&P 500 or Standard & Poor's 500 Index is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies. The index is widely regarded as the best gauge of large-cap U.S. equities. Other common U.S. stock market benchmarks include the Dow Jones Industrial Average or Dow 30 and the Russell 2000 Index, which represents the small-cap index.

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Standard And Poor's 500 Index

S&P 500 Weighting Formula

Company Weighting in S & P=Company market capTotal 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

Calculating S&P 500 Weightings

  1. Calculate the total market cap for the index by adding all the market caps of the individual companies.
  2. The weighting of each company in the index is calculated by taking the company's market capitalization and dividing it by the total market cap of the index.
  3. For review, the market capitalization of a company is calculated by taking the current stock price and multiplying it by the company's outstanding shares.
  4. Fortunately, the total market cap for the S&P as well as the market caps of individual companies are published frequently on financial websites saving investors the need to calculate them.

S&P 500 Index Construction

The S&P 500 uses a market capitalization weighting method, giving a higher percentage allocation to companies with the largest market capitalizations. The market capitalization of a company is calculated by taking the current stock price and multiplying it by the outstanding shares.

The S&P only uses free-floating shares, 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. Unfortunately, the divisor is proprietary information of the S&P and is not released to the public.

However, we can calculate a company's weighting in the index, which can provide investors with valuable information. If a stock rises or falls, we 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.

What the S&P 500 Tells You?

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, meaning company market capitalizations are adjusted by the number of shares available for public trading.

S&P 500 vs. DJIA

The S&P 500 is often the institutional investor's preferred index given its depth and breadth, while the Dow Jones Industrial Average has historically been associated with the retail investor's gauge of the U.S. stock market. 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 Industrials).

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

S&P vs. Russell Indexes

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

However, there are two large differences between the construction of the two 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.

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 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 create a U.S. all-capitalization index known as the S&P Composite 1500.

Key Takeaways

  • The S&P 500 Index or the Standard & Poor's 500 Index is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies.
  • The S&P is a float-weighted index, meaning company market capitalizations are adjusted by the number of shares available for public trading.
  • The index is widely regarded as the best gauge of large-cap U.S. equities. As a result, there are many funds designed to track the performance of the S&P.

S&P 500 Market Cap Example

In order to understand how the underlying stocks affect the S&P index, the 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. Below is an example of Apple's weighting in the index:

  • Apple Inc. (AAPL) reported 4,801,589,000 basic common shares in its fourth quarter 2018 earnings report and had a stock price of $148.26 at that time.
  • Apple's market capitalization was $711.9 billion (or 4,801,589,000 * $148.26). The $711.9 billion is used as the numerator in the index calculation.
  • The S&P 500 total market cap was approximately $23 trillion, which is the sum of the market capitalizations for all of the stocks in the index.
  • Apple's weighting in the index was 3% and is calculated as follows: $711.9 billion / $23 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.

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, but for those who want to invest in the companies that comprise the S&P, they must invest in a fund that tracks the index such as the Vanguard 500 fund.

Limitations of the S&P 500 Index

One of the limitations to the S&P and other indexes that are market-cap weighted 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 rising market cap of a company isn't necessarily indicative of a company's fundamentals, but rather 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.