The S&P 500 Index is used as a benchmark for measuring the performance of 500 U.S. equities, mostly large cap stocks. According to Standard and Poor's, the index captures 75 percent coverage of U.S. equities and is "calculated using a float-adjusted, market capitalization weighted methodology." Understanding what these terms mean makes it easy to understand how the index measures and marks stock trades of the 500 companies that make up the index value.
The S&P 500 is a prime example of a market capitalization weighted average that is continuously float-adjusted. (The Dow Jones Industrial Average is a price-weighted benchmark for U.S. stocks.) Float-adjusted means the index is continually recalculated based on the number and price of shares trading. For example, the index takes into consideration and is recalculated when one of the 500 constituent companies issues new shares or removes shares from public trading through repurchasing. These changes in market cap are also reflected in adjustments to the divisor.
Market capitalization is one means of valuing a public company, and it is calculated by multiplying the number of stock shares outstanding by the market price of one share of the company's stock. A company with one billion shares of stock outstanding at a current market value per share of $10 would be said to have a $10 billion market cap.
A weighted average means that each component of the index is not valued equally in the final sum. The weight in a weighted average refers to the value each component is given relative to every other value in the average. For example, consider a stock index with ten companies listed. Suppose the total market capitalization for the index is $100 million. If each company in the calculation represented $10 million of market cap, this would mean each company represented 10 percent of the index.
To calculate the S&P 500, figure the market cap for each company in the 500 by multiplying the number of outstanding stock shares the company has by the current market value of one share. Add all 500 of the market caps together. This gives the total market capitalization of the full index. The divisor, used as the denominator in the formula, is the base number from which adjustments are made for changes in the shares outstanding of the component companies in the index. By continually adjusting the divisor, the S&P provides a steady stream of data for comparison over time.
In the S&P 500 Index, market capitalization varies among the 500 companies. As of mid-December 2011, the average market cap of a component in the index was $22.33 billion. The largest was $391.55 billion, the smallest $0.85 billion. Looking at the weight of an individual stock provides insight into how larger and smaller companies can affect the overall index number. To calculate the market weight of each company, divide the market cap of the individual company by the total market cap of the index and remember the average is given in points rather than dollars.