What is the S&P 500?
The S&P 500 Index tracks the share prices of 500 of the largest publicly-traded companies in the U.S. This Index helps you to understand the current stock market performance.
Understanding the definition of S&P 500
The Index is formally known as the Standard & Poor's 500 Composite Stock Price Index, but conventionally is referred to as the S&P 500, with its ticker symbol is "SPX." The signature stock market index created in 1957 appears to be the primary tool for answering the question "what's happening in the stock market?". It contains about 500 largest publicly traded companies in the U.S., including 11 different sectors of the economy.
Company Weighting in S & P = Total of all market caps/Company market cap
This Index's formula confines the stock prices of 500 companies from various industries, and it's weighted using each company's value by market capitalization. Therefore, the most valuable and most prominent companies move the S&P index the most, thus, making it a more helpful reflection of the U.S. stock market. And by following the S&P 500 Index, you could easily identify whether the most significant stocks are gaining or losing value.
About the members of the S&P 500
Generally speaking, as it's been mentioned above, the S&P 500 consists of the top 500 publicly traded U.S. companies by market capitalization. As of October 2021, a company's cutoff for size is $13.1B in a market cap to be allocated in the Index. Indeed, the firms must be based in the U.S., have publicly traded stocks available for all, and be profitable in the past year. While highly valued but not profitable, companies aren't allowed to join the S&P 500 even if their value would fit in the criteria of the top 500 companies. What is more, the final word about the membership in the S&P goes to the administrator of the Index, S&P Dow Jones Indices. Altogether, those approximately 500 members count for about 80% of all the publicly traded stock in the United States.
The calculation of the S&P 500
As of October 2021, Apple, Microsoft, and Amazon are the first three companies in the Index and are reaching $1 trillion market caps. In addition, these three companies have the highest weight in the S&P 500, so their stock movements affect the Index more than the other companies.
To calculate such a proportion of the weight a particular company has in the S&P 500, you have to divide the company's market cap by the total market cap of the S&P 500.
Why is the S&P 500 useful?
Firstly, it depicts "how stocks are doing": S&P includes about 80% of all currently available stocks in the U.S. market. Therefore, it gives you a holistic picture of how the market is doing in general.
Secondly, it could be a benchmark for your portfolio: An investor usually has a collection of stocks, which they call a portfolio (read more about investment portfolio in our library). To check if your portfolio is performing well or not, you could look at the raw percentage gain (up or down). Comparing your portfolio performance to the S&P 500 is an excellent way to check if your portfolio is outperforming or underperforming in the market.
Thirdly, it's tracked by funds: Many investors prefer not to pick their stocks by themselves but to invest broadly in the U.S. stock market. An easy way to do so is to purchase shares of a mutual fund or ETF. In its turn, the mutual funds' approach mimics the makeup of the S&P.
S&P 500 vs. the Dow
There are some critical differences between the two:
A number of companies included:
The Dow is a very exclusive club - it gives prestige to the Dow's 30 members, while it's also not that representative to use it as a tool of measuring the stock market's overall performance.
The S&P 500 is more inclusive — 500 companies. It's way more objective than the Dow and could tell you more precisely on "what's happening today?"
It's important to note that: Companies with a higher share price influence the Dow the most, while the highest market cap companies affect the S&P 500 the most.
S&P 500 = weighted by market capitalization = stock price and shares outstanding
Dow = weighted by stock price only.