The Index You Need to Know
If you had to use a single financial barometer to indicate the strength of the economy, what would it be?
Even though the Dow Jones Industrial Average is the best-known and most-quoted stock index in the world, it’s so selective as to be misleading. Comprised of only 30 stocks, the Dow is less representative of the economy as a whole than are several other indices.
Paramount among those is the S&P 500, the daily de facto numerical indicator of the U.S. economy. While the S&P 500 gets second billing even in the financial media and little recognition elsewhere, its importance is vital.
- The S&P 500 is an equity index made up of 500 of the largest companies traded on either the NYSE, Nasdaq, or Cboe.
- The S&P 500 is calculated by adding each company’s float-adjusted market capitalization.
- In order to be included in the S&P 500, a company must meet certain requirements, including achieving a specific market cap (at least $13.1 billion), having a majority of its shares in public hands, and being a public company for at least a year.
- Investors who want to invest in the S&P 500 index can purchase an index fund or exchange-traded fund that seeks to match the performance of the S&P 500.
How the S&P 500 Works
First, the etymology of the term: “S&P” stands for Standard and Poor’s. Henry Poor was a 19th-century financial analyst who compiled an annual book that listed publicly held railroad companies. His publication merged with those of the Standard Statistics Company in 1941. And “500” is the number of stocks that comprise the index.
That’s it. The index includes 500 of the largest (not necessarily the 500 largest) companies whose stocks trade on the NYSE, Nasdaq, or Cboe. Like popes and Oscar winners, the components of the S&P 500 are selected by a committee. And, like the College of Cardinals and the Academy of Motion Picture Arts & Sciences, the S&P 500 committee operates within specific criteria. To qualify for the index, a company must have:
- A market cap of a certain size
- The value of its market capitalization trade annually
- At least a quarter-million of its shares trade in each of the previous six months
- Most of its shares in the public’s hands
- Had its initial public offering at least one year earlier
- Have a positive sum of the previous four quarters of earnings, as well as the most recent quarter
The minimum market cap a company must have to be included in the S&P 500 index (as of March 2022 guidance).
Between them, the NYSE, Nasdaq, and Cboe list several thousand companies. But the first criterion alone reduces that number to less than a thousand. Add a few more benchmarks, and it’s easy to see how the S&P can get down to 500 large-cap stocks suitable for inclusion.
How the S&P 500 Is Calculated
Unlike the Dow, which you calculate by just adding up the prices of the component stocks and multiplying by a constant, the S&P 500 is more complex. Instead of adding the constituents’ stock prices, the S&P 500 adds the companies’ float-adjusted market capitalization.
“Float-adjusted” means counting only the shares available to the public, excluding those held by management, governments, and other companies. There are hundreds of ostensibly “publicly-traded” companies that keep most of their shares in-house.
Stocks Removed From the S&P 500
With so many components and such stringent criteria, the S&P 500 is dynamic. S&P Dow Jones Indices, the subsidiary of S&P Global, Inc. that determines the components of the index, has little patience for slackers.
Case in point: United States Steel Corp. (X), one of the stalwarts of 20th-century industry, had been listed on the S&P 500 since its inception. In fact, at one point, U.S. Steel was the largest company in the world. Alas, it hasn’t turned a profit in years. When it fell below the $4 billion threshold in 2013, the index booted it out and made room for Martin Marietta Materials Inc. (MLM), a construction aggregate producer.
Only on Wall Street does the Iron Age give way to the Stone Age.
The S&P 500’s most recent rebalancing was announced on Dec. 3, 2021, and took effect before markets opened on Dec. 20, 2021. S&P MidCap 400 constituents Signature Bank (SBNY), SolarEdge Technologies Inc. (SEDG), and FactSet Research Systems Inc. (FDS) all were bumped up to the S&P 500, replacing constituents Leggett & Platt Inc. (LEG), Hanesbrands Inc. (HBI), and The Western Union Co. (WU)—all of which moved to the S&P MidCap 400.
S&P 500 Requirements
But even technologically adept companies have to meet the S&P 500’s list of requirements. Advanced Micro Devices Inc. (AMD) was the second-largest microprocessor producer globally but fell off the index in 2013. It was added again in 2017. This was, again, due to market cap issues. Turnover in the S&P 500 has been lower than you might think, but the length of time companies stay on the list is shrinking.
Sometimes a company buys a company it replaces on the index or spins off a large chunk of itself. S&P 500-listed companies Forest Labs, Beam, and Life Technologies were all purchased by larger companies in 2014. Other companies leave the list when they can no longer reach the market cap requirement. Typically, when that happens, the company is relegated to the index from which its replacement was promoted. For instance, in 2014, Rowan took Mallinckrodt’s place on the S&P MidCap 400.
Is there a survivorship bias here? Sure, but there’s also a survivorship bias in the economy at large. The remaining stocks flourish by virtue of remaining. One study even claims that over the decades, stocks removed from the S&P 500 have ended up outperforming their replacements.
The S&P 500 FAQs
Who Keeps Track of the S&P 500 Constituents?
The S&P Dow Jones Indices, a subsidiary of S&P Global, Inc., determines which companies get added to the index. It sets the requirements and monitors the constituents’ adherence to those requirements.
How Does a Company Get Added to the S&P 500?
To be eligible for S&P 500 index inclusion, a company should be a U.S. company, have a market capitalization of at least $14.6 billion, be highly liquid, and have a public float of at least 10% of its shares outstanding. The company must also be profitable in its most recent quarter’s earnings, and the sum of its trailing four consecutive quarters’ earnings must be positive.
Does the S&P 500 lnclude Nasdaq Stocks?
Yes, the S&P 500 is composed of 500 of the largest companies traded on the NYSE, Nasdaq, and Cboe.
What Are the 10 Biggest Stocks in the S&P 500?
The 10 largest components of the S&P 500, as of March 31, 2022, include:
Can You Just Invest in the S&P 500?
If you want to invest in the S&P 500 as a whole, you don’t need to purchase all 500 stocks individually. Several index funds and exchange-traded funds (ETFs) are available to investors. These funds are designed to track the performance of the S&P 500 index.
The Bottom Line
For the most part, the S&P 500 doesn’t convey information that differs drastically from comparable indices (or vice versa). It broadly matches the more exclusive Dow and the more inclusive Russell 2000.
Even so, the S&P 500 represents a happy medium of sorts: comprehensive enough to indicate the relative strength or weakness of the larger economy, but not so exhaustive as to include too much noise with the signal. Overall, the S&P 500 is the index of indices—the bellwether adopted by analysts, policymakers, and ordinary market participants alike.