The Standard and Poor’s (S&P) 500 index is a widely used stock market index. The index tracks the stock price performance of 500 companies with a market capitalization of over $10 billion (i.e. they are large cap companies).
The S&P 500 Index is one of the “big three” indices along with the Dow Jones Industrial Average (DJIA) and the NASDAQ. However, the S&P 500 index is often found to be a more reliable indicator because it is an actively managed index. This means that the committee that selects the stocks for inclusion in the S&P 500 can, and has, added and removed stocks from the index based on the company’s performance.
This article provides a broad overview of the S&P 500 Index. The topics it covers includes how the components of the S&P 500 are selected and what sectors make up the index. The article also how the S&P 500 is different from the Dow Jones Industrial Average (DJIA), the NASDAQ, and the Russell indexes. At the end of the article, we’ll explain how investors can use the S&P 500 Heat Map as part of their due diligence.
Why is the S&P 500 Index Important?
The S&P 500 Index (SPX) is widely regarded among institutional investors as a leading indicator for tracking changes in the economy. It is also a recognized way for investors to get exposure to a broad cross-section of the U.S. economy. The index was created in 1957 and ever since has shown to consistently outperform other asset classes.
As of August 2022, the combined market cap of all the companies in the S&P 500 index totals over $36 trillion. The total market cap is arrived at by simply totaling the market cap of every individual component of the index.
The S&P 500 index covers all major sectors of U.S. companies, it is generally considered to be the benchmark that most equity managers are measured against. Although every company in the S&P 500 is headquartered in the United States, the companies are international companies with revenue coming in from all over the world. This adds to the diversification of the index.
However, unlike other stock indexes that base their selection of composite companies exclusively on a defined set of rules, the S&P index is actively managed, meaning that the committee has some discretion in the stocks they select. This allows the committee to respond, as needed, to market events.
How Are the Companies in the S&P 500 Selected?
The companies that make up the S&P 500 index are selected by a select group of market professionals known as the Index Committee. Although commonly seen as a measure of market performance, the objective of the index is to provide an accurate picture of what is going on in the market.
In addition to choosing large cap stocks, companies must meet certain selection criteria including:
- A minimum market capitalization ($13.1 billion as of August 2022)
- A public float of at least 50%. This means that at least 50% of a company’s stock is available to the public and it has a stock price of at least $1 per share.
- They must file a 10-K annual report
- At least 50% of their fixed assets and revenues must be in the United States
- They must have reported positive earnings for the most recent four quarters
- They must have adequate liquidity as measured by price and volume
The committee rebalances the index every quarter (March, June, September, and December).
What Sectors are Included in the S&P 500 Index
The S&P 500 consists of the largest sectors in the broader market. Each sector consists of multiple industries and within those industries there are even more specific sub-sectors. The following list is accurate as of August 2022.
- Communication Services - This sector makes up approximately 11% of the index and includes the following industries: diversified telecommunication services; wireless telecommunication services; entertainment; media; and interactive media & services.
- Consumer Discretionary - This sector makes up approximately 11% of the index and includes into the following industries: automobile components; automobiles; distributors; diversified consumer services; hotels, restaurants & leisure; household durables; leisure products; multiline retail; specialty retail; textile, apparel & luxury goods; and internet and direct marketing.
- Consumer Staples – This sector makes up approximately 7% of the index and includes following industries: beverages; food & staples retailing; food products; household products; personal products; and tobacco.
- Energy – This sector makes up approximately 2.5% of the index and includes the following industries: energy equipment & services; oil, gas & consumable fuels.
- Financials – This sector makes up approximately 10% of the index and includes the following industries: banking; capital markets; consumer finance; diversified financial services; insurance; mortgage real estate investment trusts (REITs); and thrifts & mortgage finance.
- Health Care – This sector makes up approximately 14.5% of the index and includes the following industries: biotechnology; health care equipment & services; health care providers & services; health care technology; life sciences tools & services; and pharmaceuticals.
- Industrials – This sector makes up approximately 8% of the index and includes the following industries: aerospace & defense; air freight & logistics; airlines; building products; commercial services & supplies; construction & engineering; electrical equipment; industrial conglomerates; machinery; marine; professional services; road & rail; trading companies & distributors; and transportation infrastructure.
- Information Technology – This sector makes up approximately 27% of the index making it the largest sector. The sector includes the following industries: communications equipment; electronic equipment, instruments & components; IT services; semiconductors & semiconductor equipment; software; and technology hardware, storage & peripherals.
- Materials – This sector makes up approximately 2.5% of the index and includes the following industries: chemicals; construction materials; containers & packaging; metals & mining; and paper & forest products.
- Real Estate – This sector makes up approximately 2.8% of the index and includes the following industries: equity real estate investment trusts; and real estate management & development.
- Utilities – This sector makes up approximately 3% of the index and includes the following industries: electric utilities; gas utilities; independent power and renewable electricity producers; multi-utilities; and water utilities.
Why Sector Weighting Matters
As we pointed out above, the S&P 500 is commonly viewed as a measure of market performance. However, the weighting is suggesting where investor dollars are going. That’s why, as of August 2022, a company like Apple is one of the top components of the S&P 500. Nearly every mutual fund and exchange-traded fund (ETF) with exposure to technology will include AAPL stock as one of its holdings.
However, the tech sector does not always outperform the market. For example, in late 2021 and the first half of 2022, energy stocks outperformed technology stocks. Not surprisingly, the S&P dipped into bear market territory. However, the energy components of the index performed quite well.
Likewise the sectors of the index can be impacted by monetary policy. For example, rising interest rates are generally a good sign for financials. However, falling interest rates may be better for growth stocks as the cost of borrowing eases.
How is the S&P 500 Different from the Dow Jones Industrial Index?
There are several key differences between the S&P 500 and the Dow Jones Industrial Average (DJIA). To begin with, the S&P 500 is weighted by market cap whereas the DJIA is weighted by stock price. Because the S&P’s weighting is based on market capitalization institutional investors view it as a more reliable index for assessing market trends.
For example, if a large cap company issues a stock split, it would have a disproportionate effect on the Dow. By contrast, the S&P 500 looks only at the market capitalization and thus would be less affected.
Second, the S&P 500 is more diverse. It’s comprised of 500 stocks that represent a variety of sectors of the U.S. economy. The DJIA is composed of just 30 components (companies) making it much less diverse.
The third difference is in the way the components change. The components of the DJIA change from time to time. However, the changes are fairly rare and any changes tend to follow a formula.
As pointed out above, the S&P 500 index is actively managed. This allows the committee that decides on the components a great deal of flexibility regarding the S&P 500 guidelines. For example, when the insurance giant AIG was bailed out after the collapse of Lehman Brothers the S&P 500 committee kept the company in the index even though, according to its guidelines, a company must have a public float of over 50%.
A second example, on a smaller scale, took place when Google issued a stock split and issued non-voting stock, the committee recognized that some of the rules would have to be revised and then revised them again in response to major investors who expressed concerns based on the heavy volume of trading that would be required until the schedule was published.
How is the S&P 500 Different from the NASDAQ Index?
The primary difference between the two indexes is in how the sectors are weighted. Specifically, the S&P 500 is more diverse in the way the sectors are weighted. By contrast, over 50% of the weighting in the NASDAQ 100 is in the technology sector.
How is the S&P 500 Index Different from the Russell Index?
There are two key differences between how the two indices are constructed. First, the S&P 500 uses a committed to select the stocks that make up the index. The Russell index uses a formula that chooses the stocks that are included.
And second, the S&P 500 does not include the same company in different style of indices. This means that a company that appears in their growth index would not be listed in their value index. The Russell index does not make these distinctions.
How to Use the S&P 500 Heat Map
The S&P 500 Heat Map is a visual representation of the performance for stocks in the S&P 500 index. Green reflects gains and red indicates losses. The stocks are represented in boxes of different sizes (or scale) that represents the proportion of the index that the stock takes up by market cap. That’s why companies with trillion-dollar market caps such as Apple (NASDAQ: AAPL), Microsoft (NASDAQ: MSFT), and Alphabet (NASDAQ: GOOGL) are the largest squares on the heat map.
The stocks are also grouped by sector. To get a closer look at a specific sector, click anywhere on the box for that sector. At this point, the sectors are grouped into subsectors. For example, when investors click on the “Medical” sector, they’ll see many subsectors including “Pharmaceutical preparations,” “Surgical & medical instruments,” and “Hospital & medical service plans.” This allows investors to evaluate and compare stocks based on companies that are more like them.
And once investors are viewing a particular subsector, they can click on an individual company and be taken to that company’s profile page on the MarketBeat site.
