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The Dow Jones Industrial Average (INDEX:INDU) and S&P 500 (INDEX:SPAL) are both well-known stock market index in the United States. They are one of the oldest and widely followed indices, used by commentators and financial experts as leading indicators. These two market indices are mainly differentiated on the basis of their constituent stocks and the methodology adopted to assign weights to their components.
The Dow Jones Industrial Average (DJIA), generally referred as the Dow, is the second-oldest market index in the US and was invented in 1896. It is named after its inventor Charles Dow, and Edward Jones, a statistician and one of Dow's business partners. It was on March 4, 1957, when S&P 500 index in its existing form was started. Both the indices are controlled by S&P Dow Jones Indices, a joint venture majority-owned by S&P Global.
How It All Started
DJIA's founder Charles Dow, who was also the founder and then editor of Wall Street Journal, came up with an index of only 12 stocks initially to measure the performance of companies within the industrial sectors like construction, businesses related to the heavy industry. The industrial average was increased to 20 stocks in 1916 and was finally raised to its present form of 30 stocks in 1928. Now, the industrial part of the name is purely historical as most of the 30 constituent companies have nothing to do with the heavy industry. The first set of the constituent companies of the index were as below:
|The American Cotton Oil Company||Distilling & Cattle Feeding Co||North American Company||The American Sugar Refining Company|
|General Electric Company||Tennessee Coal, Iron and Railroad Company||American Tobacco Company||The Laclede Gas Company|
|Chicago Gas Light and Coke Company||National Lead Company||United States Rubber Company||The United States Leather Company (Preferred)|
Of the original 12 constituents of the Dow Jones average, only GE (NYSE:GE) still continues to be a part of the index.
The S&P 500 was first started in 1923 tracking only a few sets of stocks with the name "Composite Index". In 1926, the number of constituents stocks raised to 90 and finally expanded to the current 500 companies in 1957. The index gets its name from its founding company formed out of the merger of Poor's Publishing founded by Henry Varnum Poor and the Standard Statistics Bureau, both of which were into providing financial information of different companies. The S&P 500 is widely considered as the best indicator of how large U.S. stocks are performing on a day-to-day basis since it has stocks from a wide variety of different economic sectors including both growth stocks and value stocks.
How Are The Constituent Stocks Selected?
The constituents of both the indices are selected by a committee unlike some other indices such as the Russel 1000, which are strictly rule-based. The 30 companies of the Dow Jones Average are still selected by the editors of the Wall Street Journal publication house, which has been the practice since the inception of the index. There are no fixed rules for the companies to be included in the index but only a broad set of guidelines. The selected companies just need to be big, esteemed and important which would represent the bulk of the economic activity in the United States. The image below lists the companies presently included in the index.
The companies included in the S&P 500 are picked by a select committee at the Standard & Poor's company. The companies are assessed on the following criteria before being included in the index: market capitalization, liquidity, domicile, public float, sector classification, financial viability, and length of time publicly traded and stock exchange. All the companies in the S&P 500 index must have a market capitalization greater than or equal to $6.1 billion. The addition and removal of members are done when some companies are dropped due to mergers, (rarely) failing business or failing to pass the market cap criteria due to market capitalization decline. The S&P 500 index consists of 505 stocks (due to different class of shares of few companies) from 500 companies, with the extremely popular FAANG stocks Facebook (NASDAQ:FB), Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN) Netflix (NASDAQ:NFLX) and Alphabet (NASDAQ:GOOGL) also part of it.
How Is The Index Calculation Done?
The Dow Jones Average is a price-weighted index unlike the S&P 500 which is market capitalization weighted. The Dow index makes use of the sum of the price of one share of stock for each constituent company, hence, the stocks with higher share prices like UnitedHealth (NYSE:UNH) are given greater weight compared to others. The index value of the Dow is obtained by dividing the sum of the stock prices of the constituent companies with a unique divisor. The addition or removal of stocks to the index, stock split or dividend have an effect on the divisor and the divisor is adjusted so that the index's value is not affected.
As the S&P 500 index is a market capitalization weighted index, the companies with higher market capitalization like Apple, Microsoft (NASDAQ:MSFT) and Alphabet have higher weights than others. The S&P 500 index is derived by dividing the sum of the market capitalizations (Stock Price * Number of Shares) of each of the 500 companies with a divisor identified by the Standard and Poor’s selection committee. The divisor is adjusted whenever mergers, addition/removal of companies to the index, new stock issuance occurs. Further, this method is also float weighted as it considers only the number of shares available for public trading between institutional and retail investors in the calculation. One major difference in the adjustment of the divisor here compared to Dow Jones is that divisor remains the same in case of a stock split as the market capitalization doesn't change.
The Dow's Average was mainly compiled to measure the performance of the industrial sector within the American economy. However, it is also considered as the main benchmarks to track stock market activity. Having said that there is a criticism that Dow may not present the most accurate picture of the entire stock market since it is a price-weighted index. For instance, a $1 move in any of its 30 stocks will shift the index by an equal number of points. So, when a company with a higher price such as IBM (NYSE:IBM) or Boeing (NYSE:BA) gains or loses 1 percent, it has a bigger impact on the index than that of companies with lower prices such as Pfizer (NYSE:PFE) or Cisco (NASDAQ:CSCO). Investors prefer S&P 500 as the benchmark index for US stocks as it compromises companies from a wide array of industry sectors providing a more comprehensive picture. Further, the S&P 500 also includes all the Dow 30 companies.
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