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

What Is the S&P 500 Index? A Market Cap Benchmark

The S&P 500 Index is a list of 500 of the largest publicly traded U.S. stocks. They represent the largest and most important companies in the country, and span a broad cross-section of the economy. S&P Dow Jones Indices, a subsidiary of S&P Global, manages the index. Weighted by market capitalization, the index is considered to be one of the best gauges of U.S. equities, the stock market, and the American economy. The index actually includes 503 constituents because three companies have two share classes listed.

Weighting Formula and Calculation of the S&P 500

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

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

To determine the weighting of each component of the S&P 500, you need to calculate the index's total market cap. This is done by adding together every company's market cap.

A company's market cap is calculated by multiplying its current stock price by its outstanding shares. 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 include the S&P MidCap 400, which represents mid-cap companies, and the S&P SmallCap 600, which represents small-caps. Together, the S&P 500, S&P MidCap 400, and S&P SmallCap 600 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 uses only free-floating shares. These are the shares that the public can trade when calculating market cap. The S&P adjusts each company's market cap to compensate for new share issues or company mergers.

The index's value is calculated by adding each company's adjusted market caps and dividing the result by a divisor. The divisor isn't released to the public, but the methodology is. The S&P Index (SPX) isn't a total return index and doesn't include cash dividend gains for the companies listed.

You can calculate a company's weighting in the index, which can give you valuable information. For instance, you can get a sense about whether it might impact the overall index if a stock rises or falls. A company with a 10% weighting would have a greater impact on the index's value 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. It focuses on the U.S. market's large-cap sector, and it's also a float-weighted index, which is a type of capitalization weighting. Company market caps are adjusted by the number of shares available for public trading.

S&P 500 Competitors

S&P 500 vs. Dow Jones Industrial Average (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. 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 being more representative of U.S. equity markets because it includes more stocks across all sectors: 500 versus the Dow's 30.

The S&P 500 uses a market-cap weighting method that gives a higher percentage allocation to companies with the largest market caps. 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 index across U.S. indexes.

S&P 500 vs. Nasdaq

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

Some of the most-watched Nasdaq stock indices include:

• Nasdaq 100 Index: Includes 100 of the largest, most actively traded common equities listed on the Nasdaq
• Nasdaq Composite Index: Often simply referred to as the Nasdaq by the media, it includes more than 2,500 common stocks that trade on the Nasdaq
• Nasdaq Global Equity Index (NQGI): Includes international stocks
• PHLX Semiconductor Sector Index (SOX): The leading barometer of stocks related to the semiconductor industry
• OMX Stockholm 30 Index (OMXS30): Includes the 30 largest and most 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. This set of indexes is like the Russell index family in that both are market-cap-weighted unless stated otherwise as in the case of equal-weighted indexes.

There are two significant differences between the construction of the S&P and the Russell families of indexes. Standard & Poor's chooses constituent companies via a committee. Russell indexes use a formula to select which stocks to include. There's no name overlap within S&P style indices such as growth versus value. 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 tracks the S&P 500 Index by investing in the same stocks with similar weights as the index. The fund barely deviates from the S&P, which it tracks.

Limitations of the S&P 500 Index

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

A company's rising market cap isn't necessarily indicative of its fundamentals. It simply reflects the stock's increase in value relative to the shares outstanding. Equal-weighted indexes have become increasingly popular as a result. Each company's stock price movements have an equal impact on these indexes.

Example of the S&P 500 Market Cap Weighting

The individual market weights must be calculated by dividing the market cap of each company by the total market cap of the index to understand how the underlying stocks affect the S&P index. Let's look at this using Apple as an example.

As noted above, the company's market cap is calculated by multiplying its share price by the total number of outstanding shares. Divide the result by the total market cap of the S&P 500 to determine its weighting in the index.

Apple is one of the largest companies in the index, so it generally has a significant weighting. As a result, changes in its stock price can impact the S&P 500's overall performance. When a company like Apple has a larger weight, the more impact each 1% change in a stock's price will have on the index.

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. The index has historically been used to provide insight into the direction of the stock market. It was created by a private company but the S&P 500 is a popular yardstick for the performance of the market economy at large.