Have you ever flipped on the local or national news and heard a news anchor declare, “The S&P rose 100 points”? You may have heard a family member or friend exclaim, “My portfolio is beating the market!” Whether you know or not, these people are referring to the S&P 500.
The Standard and Poor’s, better known as the S&P 500, is an American stock market index which focuses on the 500 largest publicly traded companies in the U.S. It’s one of the most famous indices, as well as one of the most commonly-referred to.
Before we continue, Financial Professional wants to remind you that all materials in this article are educational in nature. This article is not meant to be interpreted as investment advice. Always consider your personal situation – and the help of a licensed financial professional – when making any investment decisions.
What is the S&P 500?
The S&P 500 index, or the Standard and Poor’s 500 index, was created in 1957 to include 500 companies in total. Many investors and economists use this index to measure the performance of the American economy.
Prior to 1957, the index was composed of 90 companies. That index was known as the Composite Index, or S&P 90, which was founded in 1926. Today, the index tracks the 500 largest American companies by market capitalization.
The S&P is a benchmark performance indicator for many individual and institutional investors. They use the performance of the S&P as a comparison to other investments. This is due to the large demographic the S&P covers, the fact it updates quarterly, and all companies included in the index must have traded for six to twelve months after their IPO (initial public offering). The index reports the returns and risks of the 500 companies that form the index.
The index is constantly regarded by many in the financial sector as the best single gauge for large-cap U.S. equities, with over $11.2 trillion benchmarked to the index. The S&P covers 80% of available market capitalization.
A Brief History of the S&P 500
The S&P 500 was created in 1957 and was the first ever market-cap weighted index. Since 1957, the index has seen many ups and downs.
The index closed above 100 points for the first time on June 4th, 1968 and later closed for the first time above 500 points on March 24th, 1995. Before the 2000s began, the index closed at 1,001.27 points on February 2nd, 1998.
A record high for the index occurred on February 19th, 2019 and closed at 3,013.77 points.
Although the market has seen considerable inclines, there has been unfortunate declines. Black Monday occurred on October 19th, 1987, when major geopolitical events and massive stock-selloffs caused the S&P to shed 20.4% in a single day.
More recently, the COVID-19 pandemic created a major daily decline for the S&P on March 12th, 2020, when the S&P 500 fell 12.0% in a single day.
The S&P 500 will continue to both increase and decline in the future, but maintains annual returns around 5% to 7% each year. In 1958 the index generated annual returns of 43.36% while the lowest annual returns occurred in 2008. In 2008 the index returned -37.00%.
Check out the graph below which provides the S&P 500’s year to date (YTD) returns. The YTD for the index is -4.55% as of market close for June 25th, 2020. Many investors rate their own portfolio’s YTD returns in comparison to the S&P 500’s YTD returns (often in addition to other indices).
Entrance into the S&P 500 depends upon a company’s market capitalization. Investors commonly refer to this as “market cap.” Market cap is the total dollar market value of a company’s shares. This number is calculated by multiplying the current market price of a company’s shares by the total outstanding amount of a company’s shares.
For example, if one share of stock XYZ trades on the NASDAQ for $1, this is the current market price of the stock. If stock XYZ has 100 outstanding shares, the market capitalization would be $100 ($1 current market price x 100 outstanding shares = $100 market cap). All of the companies in the S&P 500 are large-cap stocks, which means they have market caps over $10 billion.
How Does a Company Qualify for the S&P 500?
Each quarter, a committee meets to replace and keep companies in the index. This means the index is adjust accordingly each and every quarter. The companies are chosen based on their levels of liquidity; to qualify, they must have a current market price over $1.
In addition, they must:
- Have at least half of the corporation’s stocks available for the public to purchase
- Have half of the company’s assets and revenues in the U.S
- File a 10-K annual report with a regulating agency
- Have four consecutive quarters of positive earnings results.
The S&P 500 gives a higher percentage to companies with the largest market caps. This is known as index weight. Company weighting in the index is found by taking a company market cap and dividing it by the total of all the market caps found in the index. The index acts by float-weighting, which indicates that the company market caps adjust according to the number of outstanding shares available to publicly trade in the market.
The S&P is considered a benchmark performance indicator for many individual and institutional investors. This is due to the S&P’s large sector coverage and the strict qualifying guidelines for corporations to join the index. When people say “the market,” they are referring to the S&P 500.
Largest Companies in the S&P 500 by Index Weight
Below are the largest companies by index weight in the S&P 500. These companies are dominate players in their respective industries. Furthermore, they possess a very strong market share in their industry.
- Microsoft Corp (MSFT)
- Apple Inc. (AAPL)
- Amazon.com Inc (AMZN)
- Facebook Inc. A
- Alphabet Inc. A (GOOGL)
- Alphabet Inc. C (GOOG)
- Johnson & Johnson (JNJ)
- Berkshire Hathaway B (BRK.B)
- Visa Inc A (V)
- JP Morgan Chase & Co (JPM)
Current Breakdown of the S&P 500 by Sector
As of January 2020, Information technology (IT) makes up 26.2% of the S&P 500 index, the largest percentage of any single sector. Notable IT companies in the index include Apple and Microsoft.
Companies in the health care sector, such as Johnson and Johnson and AbbVie, make up 15.2% of the index.
Communication Services companies like Facebook make up 11% of the S&P 500.
- Financial companies such as Berkshire Hathaway and J.P. Morgan make up 10.4%
- The industrial sector makes up 8%
- Consumer staples make up 7.1%
- The utilities sector makes up 3.2% of the index
- Energy makes up 2.9%
- Real estate at 2.8%
- The materials sector at 2.5%
Limitations of the Index
The S&P 500 can only provide so much into the American equity market and fails to take into account small-cap and mid-size cap equities (as the index only tracks large-cap companies). In addition, the index only captures the financial markets, limiting the index only to the large-cap equity market and does not take into account what is occurring in the real economy.
The S&P 500 and the financial markets in general do not take into account various economic data like the unemployment rate, consumer price index (CPI), consumer spending, and deflation rates. All of this economic data has the power to influence the performance of the financial markets and specifically the S&P 500.
S&P 500 vs. DJIA, Russell, and Nasdaq Indices
In addition to the S&P, other common stock market indices include the DJIA, Russel 2000, and the NASDAQ.
The Dow Jones Industrial Average (DJIA), or DOW, tracks the 30 largest publicly held “blue chip” companies. Blue chip companies are historically strong companies which dominate their respective industry, such as Microsoft. Some common companies in the DJIA include Nike, Goldman Sachs, and McDonald’s.
The Russel 2000 tracks 2000 of the small cap American companies. In contrast to the S&P 500, this index is weighted entirely by small-cap companies. Two companies in the Russel 2000 you may have heard of are Five Below and Planet Fitness.
The NASDAQ-100 and the NASDAQ Composite indices are often referred to as just NASDAQ. The NASDAQ also serves as a stock exchange. It trades stocks on a computerized basis and consists of over 3,000 equities. Many companies that make up the NASDAQ exist in industry sectors like tech and biotech, such as Apple, Netflix, and PayPal.
All of these stock indices play a major role in the overall American equity market.
A Final Word
The S&P 500 tracks the performance of the 500 largest publicly traded American companies in a simple index. Ultimately, it serves to provide an indication of the American economy’s health.
In addition, the index provides a gauge of performance for various investment companies and individual investors. Investors commonly gain exposure to the S&P 500 by investing in index funds and ETFs that replicate the stocks in the index.
Questions or comments about the S&P 500? Let us know below!