The S&P 500 (or Standard & Poor's 500) Index is a market-capitalization-weighted index tracking the performance of the 500 largest U.S. companies (publicly traded, of course). For many reasons (size, diversification), the index is usually considered to be the best indicator of the performance of the U.S. stock market. Some examples of top stocks currently in the S&P 500 include Apple, Amazon, Berkshire Hathaway and Johnson & Johnson and Procter & Gamble.
How can I use the S&P 500 when I invest in equities?
- You can use it as a benchmark if you invest in U.S. equities. As it tracks the 500 largest public companies in the U.S., it provides an overall diversified view of the U.S. equity market, as well as sectors that are leading or lagging the market.
- However, one of the limitations of the S&P 500 and other indexes that are market-cap weighted arises when stocks in the index become overvalued, meaning they rise higher than their fundamentals warrant. If a stock has a heavy weighting in the index while being overvalued, it typically inflates the overall value or price of the index. While this may seem like a good sign, a rising market cap isn't necessarily indicative of a company's fundamentals, but rather it reflects the stock's increase in value relative to shares outstanding. As a result, equal-weighted indexes have become increasingly popular, whereby each company's stock price movements have an equal impact on the index.
- Interestingly, Tesla has recently been excluded from the S&P 500 even though it exceeded the threshold market cap of $6.1 billion and its earnings soared by more than three times since the beginning of the year. Analysts pointed out that the company's volatile shares, quality and sustainability of its earnings could be factors contributing to its exclusion, suggesting that the S&P 500's inclusion criteria are not purely quantitative.
Debt to Equity Ratio
Used to evaluate a company's financial leverage and is calculated by dividing a company's total liabilities by its shareholder equity.
Profit is the financial benefit realized when revenue from a business is higher than the costs and taxes involved in operating that business.
Alternative investment class composed of funds that invest directly in private companies or that buy public companies and take them private
Time of declining economic activity, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and sales.
A stimulus package is a coordinated effort by the government to increase spending and investment to "stimulate" an economy out of a downturn.
Shorting a stock
Trading strategy that tries to take advantage of the decline in a stock price by borrowing a stock and sell it now while planning to repurchase it later for a lower price.
Market-capitalization-weighted index tracking the performance of the 500 largest U.S. companies