S&P 500 Index

What is S&P'S 500 Index?

Looking for a S&P 500 definition? The 500 stocks that highlight the performance of large cap entities, selected by leading economists, and weighted by market values is referred to as the Standard and Poor's 500 Index. The S&P 500 is a leading indicator and one of the most prevalent benchmarks of the US stock market. Alternative S&P indexes include a mid-cap company index and a small cap company index, where the companies have a market capitalisation between $300 million and $2 billion.

Investment products placed on the S&P 500 vary and include exchange-traded and index funds, both of which are available to investors. The components and weightings of the Standard and Poor's 500 are determined by S&P Dow Jones indices. S&P 500 is one of the most frequently followed equity indices and is commonly considered one of the best reflections of the US stock market, yet it's different from other US stock market indices because of its weighting methodology and diversity.

Where have you heard of the S&P 500 Index?

The S&P has grown to become a favoured US stock index and is viewed as more representative of the market because it is compiled of 500 companies, whereas Dow Jones Industrial Average is made up of just 30. There is also a marked contrast in the way that the markets are defined on each index. The S&P 500 gives a higher weighting to bigger companies by using the market cap method (which is viewed as more depictive of honest market structure), whereas the DJIA gives the costlier stock a higher weighting by using the price weighting methodology.

What you need to know about the S&P 500 Index...

The S&P 500 was first known as the “composite index” when it was first introduced in 1923. It began by tracking a small amount of stocks – within a few years it featured 90 stocks and in 1957 it increased to its current amount of 500. The financial analyst Henry Varnum Poor’s original company, Poor's Publishing, merged with Standard Statistics in 1941 and assumed the brand Standard and Poor's Corporation. It's earliest daily stock index was the S&P 90 which was an index of 90 value weighted stocks.

The S&P 500 form as we know it began on 4 March 1957, and as technology has advanced the index is now able to be calculated and disseminated in real time. Because of its inclusion of both growth stocks and value stock, the S&P 500 is commonly used as a measure of the prevailing level of stock prices.

The table below details the annual S&P 500’s return since 1988:

It's interesting to compare the S&P 500 returns during periods of high and low volatility. During periods of high volatility, like in December 2002 and December 2008, the S&P 500 returns were -22.10% and -37.00% respectively. This contrasts with periods of low volatility when the S&P 500 returns were much higher – for example in December 1995 and December 2013, when the returns were 37.58% and 32.39% respectively.

Selection process

A committee selects the components of the Standard and Poor's 500 and the S&P 500 companies in a similar way to DJIA, but very unlike Russell 1000, which is stringently rule based. When analysing the acceptability of possible S&P 500 companies, the committee take into consideration the company’s quality by using these eight formal specifications:

• Market capitalisation
• Domicile
• Liquidity
• Public float
• Sector classification
• Financial viability
• Length of time publicly traded
• Stock exchange

Every one of these central criteria have individual requirements that must be met. One example is that to be added to the index a company must adhere to the specific liquidity based size requirements:

1. The market capitalization must be greater than or at least equal to $6.1 billion USD
2. Yearly dollar value, which is traded to float-adjusted market capitalization, is greater than 1.0
3. The minimum monthly trading volume of 250,000 shares in all of the six months before the evaluation date

The S&P 500 companies are selected by the committee to reflect the industries of the US economy. Each security must be publicly listed on either the NYSE or NASDAQ. 

If an investor was looking to replicate the Standard and Poor's 500 they would have great difficulty, as the portfolio would need the stocks of 500 various companies’ unique quantities to reflect the index's market cap method. Buying one of the S&P's various investment products, such as the SPDR S&P 500 ETF makes it easier for an investor to replicate the S&P 500.

The following is a list of some of the securities that are ineligible for the index:

• Limited Partnerships
• Master Limited Partnerships
• Closed-end funds
• OCT bulletin board issues
• Exchange-Traded Fund (ETFs)
• Exchange-Traded Notes (ETNs)
• Tracking stocks
• Royalty trusts
• Preferred stock
• Unit trusts
• Convertible bonds
• Equity warrants
• Investment trusts
• American depositary receipts (ADRs)
• American depositary shares (ADSs)

Other S&P indices include the S&P Small Cap 600, which embodies small cap companies and the S&P Mid Cap 400, which embodies the mid-cap companies. These two indices, along with the S&P 500, make up the S&P Composite 1500.

Calculation

To calculate S&P 500’s value, you must divide the sum of the adjusted market capitalisation of all 500 stocks by a factor, which is usually named the divisor. Even though you can access the adjusted market capitalisation on Standard and Poor's website, the divisor is regarded as the propriety of the firm.  It is however considered that the divisor’s value is approximately $8.9 billion.

The formula to calculate the S&P 500 index value is below;

P = the price of each stock in the index
Q = the number of shares available publicly for each stock

Weighting

The index has generally been capitalisation weighted. It's position regarding the cost of stocks with a higher market capitalisation has a larger impact on the value of the index than companies with less amount of market capitalisation. Standard and Poor determine the market capitalisation of each company significant to the index, accepting on the number of shares available for public trading.

Various exchange traded funds (ETFs) and index funds try to duplicate (before fees and expenses) the performance of the S&P 500 by keeping the same stocks as the index in the same quantities. Other funds use the S&P 500 as their benchmark. Mutual fund managers usually offer index funds that monitor the S&P 500, the first being established in 1976 by the Vanguard group with the Vanguard 500. As well as investing in a mutual fund that is held on the index, investors can buy shares of an ETF that reflects ownership in a portfolio of the equity securities that make up the index itself.  

The index is naturally as volatile as the market itself. In September of 2008, as a result of the subprime mortgage crisis, the index experienced 100-point swings in both directions, reaching the highest levels since 1929. Whereas 11 July 2016 saw the index rise to the highest it had been in a year, closing at 2,137.16, with the growth continuing. The graph below illustrates Standards and Poor's history from 4 January 1960 until 30 December 2016 – as you can see, growth was continuing at the end of the period examined.

Find out more about the S&P 500 Index...

Our glossary has a host of information on indexes and the markets in general. Would you like to find out more about weighting methodology or would you like to find out more about the Dow Jones Industrial Average? Kelly Angle has written a smart and concise book called S&P 500 Trading Mastery, which is worth a read for a more in-depth look at the index.