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How is the S&P 500 Calculated?

Author: David J. Kosmider (info)
Website: http://eidoan.com/
Posted: January 30th, 2007 at 9:43 pm EST
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As a follow-up to our article a few weeks ago about how the DOW is calculated, we thought it would be a good idea to explain how the S&P 500 is calculated and how these two methods are different.

To review, we explained in the DOW article that the Dow Jones Industrial Average was originally a simple average of all the stocks that Charles Dow decided to include in his index. Since then, a multiplier has been applied to the average to adjust for stock splits and other changes over the years.

The calculation for the S&P 500 is a little more complicated but it generates a more accurate reflection of the market. Weighted averages are used to calculate the S&P 500. Companies in the index are weighted by market capitalization. So the movement of the larger companies in the index effect the value of the index more than smaller companies.

Market capitalization is calculated by multiplying the number of shares outstanding by the current share price. For example, if a company has a share price of $50 and 20 million outstanding shares, its market capitalization would be $1 billion. If this stock was in a market cap-weighted index with a $5 billion company, the movement of the first company would only count for 1/5 as much of the value and movement of the index as the second company.

You could find out how much each company contributes to the index by adding up the market cap of all the companies in the index then finding what percentage of that total a certain stock has. If the total market cap of all the stocks in an index were $100 billion, then the $5 billion company would count for 5% of the total index. Most of the other indexes use either the same or similar calculation methods to what is used for the S&P 500.

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