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Home  >  Fundamental analysis  >  Stock indexes  >  Standard & Poor's 500 Stocks Composite Average (S&P 500)


Standard & Poor's 500 Stocks Composite Average (S&P 500)



There are a lot of stock indexes. Among them Standard & Poor's 500.

But first of all some words about Standard & Poor's.

Standard & Poor's, a division of The McGraw-Hill Companies (NYSE:MHP), is the world's foremost provider of independent credit ratings, indices, risk evaluation, investment research, data and valuations. With approximately 6,300 employees located in 21 countries and markets, Standard & Poor's is an essential part of the world's financial infrastructure and has played a leading role for more than 140 years in providing investors with the independent benchmarks they need to feel more confident about their investment and financial decisions. For more information, visit http://www.standardandpoors.com/.

The Standard & Poor's 500 is a market-value-weighted index (shares outstanding multiplied by stock price) of 500 stocks that are traded on the New York Stock Exchange (NYSE), American Stock Exchange (AMEX), and the NASDAQ National Market System. The weightings make each company's influence on Index performance directly proportional to that company's market value. It is this characteristic that has made the Standard & Poor's 500 Index the investment industry's standard for measuring the performance of actual portfolios.

In 1928 Standard & Poor's realized the need to disseminate its market indicator information more frequently. Instead of trying to calculate the 233 Composite on an hourly or even a daily basis, which would have been difficult to do in an era before sophisticated calculators or computers were available, Standard & Poor's created a more manageable subset of stocks. This new index was the first daily, and then the first hourly index published by Standard & Poor's. Comprised of 50 Industrial, 20 Railroad, and 20 Utility stocks, it became known as the S&P 90 Stock Composite Index.

Meanwhile, Standard & Poor's continued to calculate its original 233 Composite and 26 industry group indices on a weekly basis. In fact, Standard & Poor's continually added more companies to the original 233 in order to create new industry group indices. In 1941 there were 416 companies in 72 industry groups. By 1957 the 416 had become 500 companies. However, the S&P 90 Stock Composite still remained the only up-to-the-hour Standard & Poor's stock market indicator. Once computer technology developed, it became possible for the 500 Composite to be calculated and disseminated on a minute-by-minute basis. Historical prices for the new hourly 500 Composite were linked to the 90 Stock Composite to provide a daily record back to 1928.

The new S&P 500 Composite Stock Index consisted of 425 Industrials, 60 Utilities and 15 Railroads. All 500 stocks were listed on the New York Stock Exchange-as had been the case for the prior Standard & Poor's Indices-and constituted approximately 90% of the value of all common shares listed on the NYSE in 1957. The new 500 had a base period of 1941-43 set equal to 10 to which all future market values of constituent stocks would be compared. A base of 10 may seem a bit unusual, but that put the December 31, 1956, value of the Index at 46.67, which was very close to the average price per common share of $49.12 on that date.

The Standard & Poor's 500 Index is calculated using a base-weighted aggregate methodology; that means the level of the Index reflects the total market value of all 500 component stocks relative to a particular base period. Statisticians refer to this type of index, one with a set of combined variables (such as price and number of shares), as a composite index.

Total market value of a company is determined by multiplying the price of the stock by the number of common shares outstanding. An indexed number is used to represent the results of this calculation in order to make the value easier to work with and track over time. It is much easier to graph a chart based on indexed values than one based on actual values.

The S&P 500's base period is 1941-43. The actual total market value of the stocks in the Index during the base period has been set equal to an indexed value of 10. This is often indicated by the notation 1941-43=10. The formula used to calculate the Index is fairly straightforward. However, the calculation of the adjustments to the Index (commonly called Index Maintenance) is more complex.

Companies selected for the Standard & Poor's 500 Index are not chosen because they are the largest companies in terms of market value, or sales, or profits. Rather, the companies included in the Index tend to be representative of important industries within the U.S. economy and many also are the leaders of their industries. When the U.S. Department of Commerce developed its Index of Leading Economic Indicators in 1968 to signal potential turning points in the national economy, it chose the S&P 500 Index as one of the components.

The present form of the Standard & Poor's 500 Index (S&P 500) came into being in 1957 when the number of companies grew to 500. Since then, the S&P 500 has become a leading indicator for the overall U.S. stock market. Mutual fund managers use it as a guide to determine how well they are doing. In addition, index funds, such as the Vanguard 500 Index Fund and Exchange Traded Funds (ETFs), are based on the S&P 500. Understanding what the S&P 500 is can help you make a better return on your investments in the stock market.

The designers of the S&P 500 wanted to create an index of large-cap companies that better reflected U.S. stock markets. Up to that time, the Dow Jones Industrial Average had been the leading indicator, but had problems in that it only contained 30 companies and measured change in terms of dollar amounts rather than percentages.

By including 500 widely traded stocks in the index and calculating change in terms of a market value-weighted index, the S&P 500 has come to represent about 70 percent of the total value of U.S. stock markets. Because of this enormous volume, it has become a major indicator of movement in the marketplace as a whole.

A common misconception is that the S&P 500 automatically selects the 500 largest companies by market capitalization and revenues. A team of analysts and economists at Standard & Poor's select companies and their stocks in terms of:

market size
liquidity
industry grouping

The industries contained in the S&P 500 include energy, industrials, information technology, health care, financials, and consumer staples.

The S&P 500 uses a weighted average market capitalization when computing the effect each company has on the index. First, you compute the "market capitalization" using the following equation:

[number of shares] x [price per share] = market cap

After that we compute the index using the following formula:

Because it is an index, the S&P 500 has a base date and value of 19411943 = 10

S&P 500 = (Sum of each company's market capitalization in the current period * 10)/Sum of each company's market capitalization in the base period.

In practice, the daily calculation of the Standard & Poor's 500 Index is computed by dividing the total market value of the 500 companies in the Index by a number called the Index Divisor. By itself, the Divisor is an arbitrary number. However, in the context of the calculation of the S&P 500 Index, it is the only link to the original base period value of the Index. The Divisor keeps the Index comparable over time and is the manipulation point for all Index Maintenance adjustments.

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