By KIRK AGUER
Most market watchers are familiar with the popular Dow Jones Industrial Average (DJIA) as a measure of stock market performance. While “the Dow” may be the oldest and best-known of the major stock indices, some analysts point to the Standard & Poor’s 500 (S&P 500) as the more reliable and accurate of the two leading stock indices. Why? And what are the differences between them?
Standard & Poor’s is a leading financial information and services corporation that has been a division of The McGraw-Hill Companies since 1966. The Standard & Poor’s 500 Composite Stock Price Index, as it is formally known, was introduced in 1923 as a series of indices that originally included 233 companies and covered 26 industries. Today’s index was created in 1957 and currently encompasses 500 companies that span 122 different sub-industries in 10 sectors. The companies range in size from small industry-specific leaders to some of the largest corporations in the world.
The S&P Index Committee is responsible for establishing index policy. Companies also may be removed from the Index because of mergers, bankruptcies, restructuring or other events that the Committee deems significant. Companies are chosen based on market size, liquidity and industry group representation. The index is made up of 10 major industry sectors: Consumer discretionary, consumer staples, energy, financials, healthcare, industrials, information technology, materials, telecommunication services, and utilities. The Consumer Discretionary group is the largest in terms of the number of companies, and the financials sector is the largest in terms of market capitalization.
Because of its diversity and size, many analysts consider the S&P 500 to be a more accurate benchmark for measuring the performance of the U.S. stock market than the DJIA. The DJIA is composed of just 30 large-capitalization blue-chip stocks that measure a very small sector of the overall U.S. stock market. In contrast, the S&P 500 includes a larger number of companies with a wider range of market size. Thus, the S&P 500 is able to take a more precise “snapshot” of the overall market’s ebb and flow. In addition, all of the companies currently listed on the DJIA are included in the S&P 500.
The S&P 500 is market value-weighted. This means that each company’s stock price is multiplied by its number of shares outstanding, with each company’s influence on the index’s performance directly proportional to its market value. As a result, a larger company has more influence on the S&P 500 than a smaller one does. But because there are 500 companies, not just 30, the overall effect of a single company’s price fluctuation is limited, giving the investor a more accurate picture of the market’s activity.
If you are a market watcher who wants a more precise evaluation of market fluctuations, you will no doubt want to keep a close watch on the S&P 500 Index. (This article is published for general informational purposes and is not an offer or solicitation to sell or buy any securities or commodities. Any particular investment should be analyzed based on its terms and risks as they relate to your specific circumstances and objectives. Kirk Aguer is a financial advisor at Morgan Stanley in Santa Monica. To reach him, call (310) 319-5220.)
Originally published in the Santa Monica Daily Press print edition on April 28, 2005. Read the original PDF.