Rip Van Winkle Investing News

Posted on May 13, 2008
Filed Under Personal Finances |

By Selwyn Gerber:

All of the stocks in the S&P 500 are large publicly held companies and trade on the two largest US stock markets, the New York Stock Exchange and Nasdaq. After the Dow Jones Industrial Average, the S&P 500 is the most widely watched index of U.S. stocks. It is considered to be a leading indicator of U.S. economic activity and is a component of the Index of Leading Indicators maintained by the government.

Investments

Many index funds and exchange-traded funds track the performance of the S&P 500 by holding the same stocks as the index, in the same proportions, thereby attempting to match its performance, before fees and expenses. Partly because of this, a company which has its stock added to the index may see a quick jump in its stock price as the managers of the mutual funds must purchase that company’s stock in order to match the funds’ composition to that of the S&P 500 index. Likewise a company being deleted from the index may experience a sudden decline in its stock price.

Index funds

In stock and mutual fund performance charts, the S&P 500 index is often used as a baseline for comparison. The chart usually shows the S&P 500 index, with the performance of the target stock or fund overlaid. Managers seek to outperform the index, otherwise they add no value to the investment process.

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The first S&P stock market index consisted of 90 companies and was called the S&P 90. It was introduced in 1923 and was published on a daily basis; no intraday quotes were available for the index at that time. A larger index of 423 companies was also published weekly. On March 4, 1957, a broad, real-time stock market index of 500 stocks was introduced. This was made possible by advancements in computer technology which allowed the index to be calculated and distributed in real time. While the S&P 500 index was created in 1957, it has been extrapolated back in time making data for the series available since 1923.

The S&P 500 includes both “growth” stocks, and generally less volatile “value” stocks; it also includes stocks from both the NASDAQ stock market and the NYSE. Subindexes are available to track the growth and value components of this, and many other indexes.

Growth stocks represent companies whose earnings are expected to grow at an above-average rate relative to the market. A growth stock usually does not pay a dividend, as the company would prefer to reinvest retained earnings in capital projects. Most technology companies are growth stocks

A value stock is expected to grow at a slower rate but trades at a low price relative to fundamental measures like dividends, earnings, and sales. Common characteristics of these stocks include a high dividend yield, low price-to-earnings ratio or a low price-to-sales ratio and a larger percentage of real tangible assets in the balance sheet than would be found in the balance sheet of a growth stock.

The stocks that make up the S&P 500 are selected by committee. This is similar to the Dow 30. The index does typically include about a dozen non-U.S. companies. This group includes some formerly American companies that are now incorporated outside of the United States and allowed to remain in the S&P 500 after their expatriation, and also several foreign companies that have never been incorporated in the United States.

The committee selects the companies in the S&P 500 to represent various industries in the United States economy. In addition, companies that do not trade publicly (such as those that are privately held) and stocks that do not have sufficient liquidity are not in the index - a notable example of an illiquid stock not in the index is Berkshire Hathaway, which in 2007 had a market capitalization larger than all but 12 of the members of the S&P 500, but which also had a stock price greater than $130,000, and so was very difficult to trade. By contrast, the Fortune 500 attempts to list the 500 largest public companies in the United States by gross revenue, regardless of whether their stocks are easily traded, without adjustment for industry representation, and excluding companies incorporated outside the United States.

The S&P 500 index was originally market-value weighted. That means the price of each stock is multiplied by the number of shares issued by the company to find the market cap of the stock. Market caps are summed, and that total was divided by 500 in this case. This gives large cap stocks more impact on the index than companies whose market valuation is smaller.

Rip Van Winkle Investing News

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