When you read about the S&P 500, Nasdaq, Dow Jones, do you wonder “What do these represent?” “What are they comprised of?” “How do these indices measure different parts of our investment markets?” “How do stocks get assigned to different indices?” This article takes a broad look at these three common indices and how they compare to each other.
S&P 500
- Ticker – INX
- Founded in 1923, the Standard and Poor’s Index included 223 companies across a variety of industries/sectors. The list expanded to 500 companies in 1957 and the index was renamed S&P 500.
- The U.S. Index Committee reviews all applicants before deciding on 500 companies. To qualify for consideration, a company must:
- Have been a publicly-traded company for at least one year,
- Be considered “large” (market cap is more than $10B),
- Have a significant number of outstanding shares,
- Be financially viable, and
- Contribute to sector balance.
- Although the index covers most sectors of the US economy, the reliance on “market cap” can skew the sector breakdown so that the index is no longer representative of the economy as a whole. For example, as of February 2024, the largest 10 companies in the S&P 500 (2% of the index holdings) accounted for more than 30% of the index’s total value.
Nasdaq Composite
- Ticker – IXIC
- The term “Nasdaq” is often used to refer to the Nasdaq Composite, an index of more than 2,500 stocks listed on the Nasdaq exchange.
- The Nasdaq was launched in 1971 after the Securities and Exchange Commission (SEC) encouraged the National Association of Securities Dealers (NASD) to automate the market for securities not listed on an existing exchange. Nasdaq is an acronym for National Association of Securities Dealers Automated Quotations.
- Nasdaq’s trading technology is used by 100 exchanges in 50 countries.
- Nasdaq has long been associated with technology and growth stocks.
Dow Jones Industrial Average
- Ticker – DJI
- Created by Charles Dow in 1896, the Dow Jones Industrial Average (DJIA) was meant to be a measurement of the broader US economy because the performance of industrial companies was closely correlated to the growth of the economy.
- The DJIA is a price-weighted index that tracks 30 large, company stocks (typically blue-chip stocks) traded on the New York Stock Exchange (NYSE) & the Nasdaq.
- When the DJIA was launched, it had 12 industrial companies. Now, the 30 companies come from all sectors except utilities and transportation, which have their own indices and are intentionally excluded from the DJIA.
Definitions
What do these terms mean and how do they fit in the discussion of the above indices.
Growth- Growth stocks are attractive for their potential of capital appreciation (stock price going up). The term usually applies to companies that focus on growing revenue and investing in research and development in the interest of growth. Some of these companies may not be profitable at the outset, but can become profitable with innovative technologies allowing them to penetrate existing markets and create new ones. Paying a dividend to shareholders is not a priority and investors would not buy the stock to obtain dividend income.
Value- Value investing seeks companies that are worth more than what they are currently trading for. The belief is the market overacts to bad news, providing an unwarranted discount. Financial analysis using traditional methods like book and intrinsic value (strong balance sheets, price to earnings) allow investors to screen for value investments.
Tech Stocks- Think computers and everything related to them. That includes hardware, software, accessories, and service companies that provide technology support to companies and end users.
Blue-chip Stocks- Large, well-established companies with good fundamentals / financials. They tend to be leaders in their industries. They are looked at as stable and better equipped to survive economic downturns. Dividends are often a benefit to owning stock of blue-chip companies.
Market-cap- The total value of all of a company’s stock when multiplying the total number of outstanding shares by the stock price.