The Standard and Poor’s 500 Index, or more commonly referred to as the S&P 500, is a stock market index that measures the performance of 500 large publicly traded companies traded in the US stock markets.
The S&P 500 is frequently used as a benchmark when evaluating the performance of a fund manager, or stock portfolio because most financial analysts believe the S&P 500 index best represents the larger companies traded on the US stock exchanges. Included are large companies that are the leading companies in the leading industries. Approximately 75% of the value of all US companies is included in the S&P 500. Together, they represent the economy’s sectors, thereby providing a good representation of the US economy. Since stock prices are influenced by investor expectations of future profits, which in turn are affected by the strength of the economy, a change in the index is considered a leading indicator of the economy’s future and is included in the Conference Board Leading Economic Index.
Both the S&P 500 and the DJIA measure the US stock market’s performance and have similar movements.
Source: Yahoo Finance
But most financial planners favor the S&P 500 to the Dow Jones Industrial Average (DJIA) because the S&P 500 includes 500 companies compared to the DJIA’s 30. Another reason analysts prefer the S&P 500 is that it is a market capitalization-weighted rather than price-weighted. This gives added influence to companies with a higher market capitalization. For example, most financial analysts believe Exxon-Mobil should carry more weight than 3M since it is a much larger company. Yet, because the DJIA is price-weighted, 3M would have a greater impact on any change in the DJIA. To illustrate let’s compare 3M and Exxon-Mobil, two companies that are included in the S&P 500 and the DJIA. On June 22, 2020, 3M stock traded at $157 and its market capitalization was approximately $90 billion. Exxon-Mobil share price equaled $46, but its market capitalization was $196 billion. Exxon-Mobil would have more than twice the influence on the S&P 500 index than 3M because it has more than twice 3M’s market capitalization. In contrast, 3M has a greater influence on the DJIA because the DJIA is price-weighted, meaning stocks with a higher price are weighted more. In summary, a $1 change in the price of Exxon-Mobil stock would have more of an influence on the S&P 500 than a $1 change in the price of 3M shares, but a $1 change in Exxon-Mobil would have less than a $1 change in the DJIA.