Short Answer: The S&P 500 is an index of the 500 largest public companies in the US. This list is often seen as a barometer for the U.S. economy as a whole.
If you’re just beginning to follow the stock market, the term “S&P 500” might sound like just another phrase in the alphabet soup that is the world of finance. In reality, the S&P 500 is one of the more important indices in the market and takes the temperature of the U.S. economy overall. Read on to learn about S&P 500 criteria, the history of this index, and why you should be paying attention to it.
What is the S&P 500?
Let’s start with what the S&P is, then we will cover why it’s important.
While the stock market is composed of domestic and international components, the S&P (short for Standard & Poors) is the most widely tracked index, and it serves as a commonly used benchmark to which many other investments are compared.
An index is a collection of assets, in this case, grouped stocks. The uniting factor of the S&P 500 is its holdings are only from the top 500 listed stocks on the New York Stock Exchange and NASDAQ.
The S&P 500 started in 1957 (with 90 companies), but Standard & Poor’s has been around in some form since the 1860s. Originally, it was just Poor’s Publishing, which printed railroad travel books back then. In the 1940s, Poor’s merged with Standard Statistics Bureau, a financial data publisher. Today, S&P Global is a benchmark for the U.S. stock market data and indices.
While there are plenty of different indices from other companies nowadays, the S&P 500 was groundbreaking for a few reasons:
- It was the first index to be computer-generated
- It was and still is published daily
Now that you understand its historical significance let’s explore how companies earn their spot in the S&P 500 today.
S&P 500 Criteria
Each quarter, a committee “rebalances” the index by removing or adding companies to the list.
To qualify for the S&P 500, a company must be:
- Publicly traded, with at least half of the shares publicly available
- Have a stock price of at least $1
- Be based in the US
- Have a market cap of at least $8.2 billion
- Report positive earnings in its most recent quarter
- The sum of its earnings from the past four quarters must be positive
It’s also important to note that once a company qualifies for the S&P 500, it’s not an invitation for life. Companies have to work to stay in the S&P 500. A drop in earnings could knock it out of the index.
A quick look at the S&P 500, and you’ll probably recognize a few of its constituents, including:
- Apple Inc.
- Microsoft Corp.
The S&P 500 weighs each of its holdings accordingly. It’s that calculation and data that’s helped establish the S&P 500 as a bellwether for the entire U.S. economy. While it’s only a portion of the stock market, it can help predict the market trends as a whole.
Why should you pay attention to the S&P?
To put it simply, the S&P 500 is basically a cheat sheet of the U.S. stock market. It tracks some of the most prominent players in the market. The index can be a great tool to understand the overall economy. If you’re just beginning to familiarize yourself with the stock market, following the S&P 500 is much easier than tracking individual stocks. The S&P can give you a bird’s-eye view of the market and economy. A single stock offers a more limited view.
The most heavily weighted companies in the S&P 500 (as of December 2021) are:
- Berkshire Hathaway
- JP Morgan Chase
Given this list, it’s probably a little more evident why the S&P 500 reflects the economy.
If Amazon stock is down, there’s a chance that unemployment is up. If Apple and Berkshire Hathaway’s stocks are up, chances are, the economy is strong with discretionary spending and home buying.
Now, while these aren’t golden rules, we can use the S&P 500 and its top performers to learn more about the domestic economy.
More often than not, the S&P is used as a metric to compare other investments—for instance, if you have a retirement account, a progress report might have the account performance plus the S&P for comparison.
The S&P 500 is an excellent tool for anyone to understand the stock market better, as it tracks some of the country’s most significant players in the business. Its trends typically reflect the market and economy as a whole.
What is an index?
In the stock market, an index tracks groups of stocks. Some indices track the entire market, while others track an industry, such as Alternative Energy or Technology.
Companies and firms use historical data and calculations to help weigh investments within an index to mirror an industry or the economy. People often choose to invest in indices because they’re a simpler alternative to investing in single stocks or other assets. Expertly calculated, indices may make day-to-day investing easier for the average investor.
What are the Dow Jones and the S&P 500?
Listen to any market report, and you’re bound to hear Dow, NASDAQ, and S&P 500 mentioned in the same breath. But, what are these terms, and what do they mean in relation to each other?
“The Dow” is often used as shorthand for the Dow Jones Industrial Average (DIJA). The Dow is similar to the S&P 500. It’s also a stock market index that can be used as an indicator of the overall health of the U.S. economy.
NASDAQ is the Nasdaq Stock Market, a stock exchange based in New York City. Not to be confused with the New York Stock Exchange (also based in New York), the NASDAQ is the second-largest exchange in the world. Nowadays, its trades all occur online, not in a physical location.
Diving deeper into the S&P 500
If you’re excited to learn more about this historical index, check out Troutwood’s Map of the Markets and the “The Missing Second Semester,” a book widely used in high school and college classrooms that dedicates an entire chapter to the S&P 500 and the important role it plays for many investors.
Want to learn more about investing and your financial future? Sign up for Troutwood’s newsletter for insights delivered right to your inbox.