What is the S&P 500 Index?
The Standard and Poor’s 500 Index, abbreviated as S&P 500 index, is an index comprising the stocks of 500 publicly traded companies in the U.S. with the highest values of market capitalization. Market capitalization, or market cap, is the product of the number of outstanding shares of a company and its share price. The companies selected to represent the S&P 500 are the biggest and most well-established in the U.S. that are open for public trading, such as Apple Inc., Amazon.com Inc., Johnson & Johnson, and Microsoft Corp.
A stock market index is defined as a measure of the performance of the entire market, or a subset thereof. It comprises a select group of stocks that represent either the market as a whole or a specific segment of it. Variations in the trading prices of the stocks serve to indicate how the market index moves, and the investor can evaluate market performance by comparing current price levels with past ones.
- The Standard and Poor’s 500 Index, abbreviated as S&P 500 index, is an index comprising the stocks of 500 publicly traded companies in the US with the highest values of market capitalization.
- The companies are the biggest and most well-established in the US that are open for public trading, such as Apple Inc., Amazon.com Inc., Johnson & Johnson, and Microsoft Corp.
- The S&P 500 index is considered a good representative of the US large-cap market, and it is calculated using a free-float market capitalization method.
Criteria for Inclusion in the S&P 500
A company must meet the following criteria to be selected by the Index Committee and be included in the S&P 500 index:
- The company should be from the U.S.
- Its market cap must be at least $8.2 billion.
- Its shares must be highly liquid.
- At least 50% of its outstanding shares must be available for public trading.
- It must report positive earnings in the most recent quarter.
- The sum of its earnings in the previous four quarters must be positive.
Any company that satisfies the above conditions can be considered for inclusion in the index. However, the ones that actually make it are the ones with the largest market capitalization. Since share prices fluctuate over time, the constituents of the index keep changing.
In reality, the S&P 500 index actually comprises 505 stocks, instead of 500. It is because multiple classes of shares of several companies, such as Google, Facebook, and Berkshire Hathaway, are listed on the index.
How is the S&P 500 Index Calculated?
The S&P 500 index is considered a good representative of the U.S. large-cap market. Large-cap stocks refer to companies with a market capitalization of at least $10 billion. If pharmaceutical companies represent 5% of the entire US large-cap market, the index will include such companies in the same proportion.
The index is calculated using the free-float market capitalization method. Free-float market capitalization refers to the value of shares that are available for public trade. It excludes all shares held by company executives, owners, or promoters. It is obtained by multiplying the total value of market cap with a float factor, or an Investible Weight Factor (IWF), which is the fraction of shares available for public trading.
Market Capitalization = Outstanding Shares * Current Market Price
Free-Float Market Capitalization = Market Cap x IWF
Index value = Total Free-Float Market Cap / Divisor
The index divisor is a number fixed by S&P to moderate the value of the index and report a figure that is manageable and understandable. There is no fixed method for arriving at the divisor, but its value is revised at regular intervals to keep the index consistent despite material changes that may affect it. The changes include the exit of an existing stock from the list, a new one entering in its place, buyback of shares, among others. It ensures that the value of the index is affected only by price fluctuations.
Consider the following illustration to understand how the index is calculated. Assume that the index is made up of 5 stocks: A, B, C, D, and E. The following information is available on these stocks:
The total free-float market cap is $9,467,250. Dividing the figure by the index divisor will give the value of the index.
The actual total market cap of the S&P 500 was US$30.5 trillion, and the value of the index was 3363.00 on September 30, 2020.
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