What is “The S&P Index”?
To measure the performance of stocks and the overall markets, investors require a benchmark – known as a stock market index. The S&P 500 index, considered the barometer of the overall health of the US stock market or overall stock market’s performance in the US, is a broad-based index of 500 large, industry-leading companies in the US (whose stocks trade on NYSE or NASDAQ) and tracks the performance of these companies.
Investors can use indices to measure the relative performance of a stock market and its volatility (which varies from time to time). Moreover, investors wish to judge the performance of their stock market investments or portfolio, in terms of both absolute returns and how well or badly did the same perform when compared to the market as a whole, or a particular sector of the market. Investors are keen to know if they have outperformed or underperformed the stock market.
Key Learning Points
- The 500 publicly traded companies included in the S&P 500 index are from across 11 sectors
- The S&P 500 is a capitalization weighted index. In such an index, the weight of a particular stock is determined its market capitalization
- The S&P 500 is a broader and more representative index of large company stocks in the US, than the Dow Jones Industrial Average (DJIA)
- An investor can calculate the return of the S&P 500 index for any particular month or year and compare the same with the overall return on the stocks in their portfolio
- There are several criteria that a company has to meet, in order to be included in the S&P 500
- There are two practical ways to invest in the S&P 500 index – though purchasing an index fund or an Exchange Traded Fund (ETF)
S&P – Sectors, Criteria, Investing and Rate of Return (%)
Professional investors tend to pay greater attention to the S&P 500, rather than the DJIA, as it is the broadest representative of US stocks or the US stock market – the 500 companies that are included in the S&P 500 account for approximately 80% of the overall value of the stock market in the US. The stock contribution is weighted by market cap.
The 500 publicly traded companies included are from across 11 sectors (which are further divided into 24 industry groups, 69 industries, and 158 sub-industries), These sectors are Information Technology, Financial Sector, Consumer Discretionary, Industrials, Consumer Stables, Communication Services, Energy, Utilities, Real Estate and Materials.
There are several criteria that a company has to meet, in order to be included in the S&P 500. Some of the key ones are market value (i.e. market capitalization), liquidity, size of public float, profitability and is the company headquartered in the US.
There are two practical ways to invest in the S&P 500 index. The first is to buy an index fund (a passively managed mutual fund) that tracks or replicates this index and the second is to buy an Exchange Traded Fund (ETF) that also tracks or replicates this index. In addition to index funds, there are many S&P 500 ETFs that are available. Among these ETF’s the most widely traded ones are iShares Core S&P 500 ETF, Vanguard S&P 500 ETF and SPDR S&P 500 ETF Trust.
If we were interested in calculating the S&P return for the month of December year 1, we would have to know the starting and end price of the S&P 500 index (i.e. the first and last trading days of December year 1). If we assume that the S&P 500 index opened at 2,500 on December 1, year 1 and closed at 3,000 on December 31, year 1, we can calculate the return using the formula mentioned below.
S&P 500 Return (December year 1) = 3,000 – 2,500/ 2,500 * 100 = 20%
(i.e. during December year 1, the S&P increased in value by 20%).
An investor can easily compare the overall return on the stocks in their portfolio to the S&P 500.
Other well known S&P indices include S&P SmallCap 600, S&P MidCap 400, S&P 900 and S&P composite 1,500.
The S&P 500 is a capitalization weighted index. In such an index, the weight of a particular stock is determined by multiplying the market price of this stock by the number of outstanding shares (= market capitalization of that stock).
In the workout, we assume that a stock market index (H&T 500) has five constituent companies. Further, the total market value of this stock market index is computed.
Company A has a weighting of 31.9% in the index and the highest market capitalization (despite the fact that its current stock price is the lowest among the 5 constituent companies) Consequently, it will have a greater impact on the movements or changes in the H&T 500 stock market Index, when compared to other constituent companies of this index.