What is an index?
A stock market index is a collection of stocks representing a sub-section or entire market. They serve as quick references to see how certain aspects of the market or the whole market are doing. Numerous indexes exist, and it is even possible for an individual to create an index to track what is important to them.
Who makes it?
The SP500 is maintained by S&P Dow Jones Indices, a division of S&P Global (Ticker: SPGI). They are a large company that maintains many common indexes and is the largest credit rating agency. Their primary business is gathering and selling information.
What is it?
The SP500 is a component of the SP 1500 Composite Index. The SP500 represents the 500 largest companies by market capitalization in the SP 1500. Market cap is defined as issued shares (aka stocks) multiplied by the current stock price. Another way of thinking about market cap is how much money it would cost to buy all the company shares. The other components of the SP1500 are the SP Mid Cap 400 and SP Small Cap 600. All components of the SP1500 have the same eligibility criteria and can be moved between each other as market cap changes. Due to the nature of the markets, it is possible for there to be less than the desired number of companies in an index.
Link to the official SP500 brochure: https://www.spglobal.com/spdji/en/documents/additional-material/sp-500-brochure.pdf
Who can be included in it?
Only US-based publicly traded companies are allowed to be included. Currently, the only allowed organizational structures are Corporations (including REITs) and Common stock.
What are the qualifications to be included?
Basic Requirments:
The company must have a market capitalization of greater than USD 14.6 Billion.
Most recent quarterly earnings positive
Sum of the most recent four quarters’ earnings positive
There are further requirements which will be linked below.
It is worth noting that financial viability is not a consideration for the index. A company is not promised to be a runaway success because it is included in the SP500.
Link to the complete list of requirements: https://www.spglobal.com/spdji/en/documents/methodologies/methodology-sp-us-indices.pdf?utm_source=pdf_brochure
How is it run?
The index is reconstructed annually, and those that don’t meet the requirements are removed and replaced with those that do. Every quarter the index is rebalanced, meaning percentage holdings are updated to reflect the market cap changes that occurred during the quarter. A company can be added during a quarterly rebalance in some special cases.
Why do we care about it?
The SP500 serves as the benchmark for most investments. It is also what most people think of when they think of the market. This phenomenon of the SP500 being thought of as the stock market comes from its market cap requirement. Since companies must have a large market capitalization to be part of the SP500, it is common for individuals to have heard of or done business with its members. For example, the SP500 contains household names such as Costco, Walmart, and Pepsi.
Another advantage of tracking the SP500 is its utilization of sectors. Breaking the SP500 into sectors allows us to see how different areas of the SP500 are performing in comparison with one another and the index. The eleven sectors are shown below with their tickers.
The other reason we care about the SP500 is the ease of investing directly in the SP500 through index-tracking ETFs such as SPY. There is also sector ETFs that allow you to target your investing to specific sections of the SP500.
We must know and understand what we are using to invest. Even large indexes can suffer from wild swings, such as in 2021 and 2022.
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