What Standard & Poor’s 500 Tell You About the US Stock Market
The S&P 500, or to give it its full title the Standard & Poor’s 500, is one of the American stock market indices. It is based on the market capitalisations of 500 big companies that have their common stock listed on either the NASDAQ or the NYSE. The components of the S&P 500 and the weightings that they are given are decided by the S&P Dow Jones Indices. The S&P 500 is different from the other United States stock market indices such as the NASDAQ Composite Index or the Dow Jones Industrial Average because of its weighting methodology and its diverse constituency. The S&P 500 is believed to be one of the top US stock market representations, and thus it is one of the most popular equity indices followed by traders, standing as a barometer for the health of the American economy. The S&P 500 was created by S&P Dow Jones Indices, which is a joint venture with majority ownership by S&P Global. As well as maintaining the S&P 500, S&P Dow Jones Indices publishes numerous other indices, including the S&P MidCap 400, the Dow Jones Industrial Average, the S&P Composite 1500 and the S&P SmallCap 600. Traditionally the index has been capitalisation-weighted: Stocks with higher market capitalisations will have a bigger impact on the index’s value than companies with smaller market caps. However, today the index is float-weighted. This means that Standard & Poor’s calculates each company’s market capitalisation with relevance to the index by only using the number of shares the company has available to be publicly traded: i.e., their float. This transition took place in two steps, the first in March 2005 and the second in September 2005.
The History Of the S&P 500
The S&P 500 was originally known as the Composite Index when its initial stock index was introduced in the year 1923. At first, it only tracked a few different stocks; however, in 1926, just 3 years later, the index expanded to encompass 90 stocks, before expanding up to its current total of 500 in 1957.
In 1860, Henry Varnum Poor founded a company called Standard & Poor’s, which gave financial analysis and information. In 1941 his original company, Poor’s Publishing, was merged with another company, Standard Statistics (which had originally been named the Standard Statistics Bureau when it was formed in 1906), and it was at that time that the name Standard and Poor’s Corporation came into being. The S&P 500 was created in its current form in 1957. Today, however, the index can be calculated and disseminated in actual real time. Because it includes both value stocks and growth stocks, the S&P 500 is broadly regarded as a good measure of the general level of stock prices. In 1962, Standard & Poor’s forged an agreement with Ultronic Systems Corp which gave Ultronics control of the computation of a number of indices, including the S&P 500 Stock Composite Index, the 50 Stock Utility Index, the 425 Stock Industrial Index and the 25 Stock Rail Index, as well as computing and reporting the 94 S&P sub-indices.
Selection Criteria for the S&P 500 Index
All of the S&P 500 index components are chosen by a committee in a similar way to the Dow Jones Industrial Average. This is different, however, from other indices such as the Russell 1000, which has rule-based selection criteria. When the committee consider whether a new addition is eligible to be added to the index, there are eight different criteria that the company must meet, as follows:
- Market capitalisation
- Public float
- Sector classification
- Length of time in public trading
- Financial viability
- Listing exchange.
The companies that are chosen to appear on the S&P 500 are representative of the various industries that contribute to the American economy. Companies must meet certain requirements regarding liquidity, as follows:
- The market capitalisation must be equal to or more than US$5.3 billion.
- The annual dollar value traded to float-adjusted market capitalisation must be more than 1.0.
- The company must have a minimum trading volume per month of 250,000 shares for each of the 6 months before the date of evaluation.
Securities must also be listed publicly on either NASDAQ (including the NASDAQ Capital Market, NASDAQ Select Market or the NASDAQ Global Select Market), or on the NYSE (including NYSE MKT or NYSE Arca). Some securities are not eligible to be included on the index, and these include the following:
- Limited partnerships
- OTC bulletin board issues
- Master-limited partnerships
- Closed end funds
- Royalty trusts
- Preferred stock
- Tracking stocks
- Unit trusts
- Convertible bonds
- Investment trusts
- Equity warrants
- MLP IT units
Not only does the index include US companies, but also companies that have never been incorporated in America, and those that were once US-incorporated but that have now re-corporated outside the country.
Maintenance of the Index
So that the S&P 500 Index can remain consistent over a longer period of time, adjustments are made to capture any corporate actions that could affect market capitalisation. This includes events such as dividends, share issuances, or any restructuring event such as a spin-off or a merger. To remain representative of the United States stock market, the component stocks on the S&P 500 are periodically changed, with some components being removed and some added. All actions that affect the index’s value are adjusted using a divisor to prevent change occurring merely because of corporate financial actions. Any divisor adjusment takes place after trading closes for the day, and after the closing value of the S&P 500 index has been calculated. The various actions that require a divisor adjustment to be made include the following:
- Share issuances
- Share repurchases
- Special cash dividends
- Company changes
- Offerings of rights
Other educational materials
- Australian Securities Exchange (ASX)
- CAC 40 Index
- Dow Jones Industrial Average
- Paris Stock Exchange – Euronext Paris
- Composite Index
- Toronto Stock Exchange (TSX)
Recommended further readings
- “Price and volume effects associated with changes in the S&P 500 list: New evidence for the existence of price pressures.” Harris, Lawrence, and Eitan Gurel. The Journal of Finance 41, no. 4 (1986): 815-829.
- The temporal price relationship between S&P 500 futures and the S&P 500 index. Kawaller IG, Koch PD, Koch TW. T The Journal of Finance. 1987 Dec 1;42(5):1309-29.