How the world's three most famous stock indexes work

S&P 500: Sophisticated algorithms

The S&P 500 Index is one of the best-known and widely used stock indexes in the world. It tracks the performance of the 500 largest publicly traded companies in the United States. These companies include a variety of industries such as technology, finance, energy, health care, consumer products and others. The history of the S&P 500 began in 1923 when Standard Statistics and Poor's Publishing formed a joint organization to create an index that would track the performance of the largest U.S. companies. At the time, the index included 233 companies and was calculated on a weekly basis. In 1957, the number increased to 500 and the index was renamed the S&P 500.

It is interesting that the first calculation of this index was done manually using a calculator. Today, the calculation is carried out using computers and sophisticated algorithms that take into account the market capitalization and market movement of the shares of individual companies. The S&P 500 Index is considered a representative indicator of the development of the US stock market and is widely followed by investors, analysts and economists around the world. The index is often used as a benchmark for evaluating the performance of other investment instruments, products and portfolios. Its value is available to the public and is updated in real time during trading days. The average annual return of the index since 1957 is 11.88%. The index is led by Apple, which, with a market capitalization of USD 2.89 trillion, now accounts for 7.5% of the index. Second and third place goes to Microsoft and Amazon. That's followed by Nvidia Corp, Tesla, Berkshire Hathaway and two share classes of Google's parent company, Alphabet.

Currently, the S&P 500 represents roughly 80% of the market capitalization of the US stock market. Its composition is regularly updated, with companies selected on the basis of a number of criteria. Only companies with a market capitalization of more than USD 12.7 billion can be included in the index. In addition, the minimum monthly trading volume must reach 250 thousand shares, in each of the 6 months preceding the inclusion of the company in the index. Many may be surprised by the fact that the S&P 500 index technically tracks more than 500 stocks. Although it is limited to 500 companies, some companies have issued more than one class of stock, meaning the index tracks two or more of these classes. In fact, in 2023, the S&P 500 index tracked 503 stocks. The three "extra" share classes come from Alphabet Inc, Fox Corporation and News Corp.

Dow Jones 30: Balanced Index

The Dow Jones Industrial Average (also known as the DJIA or DJ30) is also one of the world's best-known stock indexes. Unlike the S&P 500, it tracks the performance of the 30 largest companies in the US. The index was founded in 1896 by Dow Jones & Company. The original Dow Jones index included 12 companies, most of which were in heavy industry, which is why the index has the word 'Industrial' in its name. Gradually, the number of companies in the index increased until it reached 30 companies in 1928, a number it has maintained to this day.

The composition of the Dow Jones 30 has changed over time and today includes large and established companies in a variety of industries such as financials, pharmaceuticals and consumer products. Although it is often referred to as the oldest index in history, that is not true. In fact, two years earlier, Charles Dow created the Dow Jones Transportation Average, which is officially the oldest index in the world. The Dow Jones 30 is a price-weighted index. This means that the value of the index is based on the share prices of individual companies. Companies with higher share prices have a greater influence on the development of the index. Currently, Unitedhealth Group Inc. has the largest weighting in the index at around 9%. Number two belongs to Microsoft and number three to Goldman Sachs. Over its history, the index has managed to grow at an average annual return of 5.47%.

Like the S&P 500, the Dow Jones is often seen as an indicator of the overall performance of the U.S. stock market and the economy as a whole. As a rule of thumb, each of the Dow Jones components is also a component in the S&P 500. However, it should be kept in mind that it tracks only 30 companies and so does not provide such a detailed view of the overall market compared to other indexes. Rather, it is used to track the best that America has to offer at the moment, as it is made up entirely of blue-chip companies. There are a few interesting facts associated with the long history of the index. For example, General Electrics has been part of the index for more than 116 years. It was one of the first 12 companies in the index, but dropped out shortly thereafter. In 1907, the company managed to return and remain in the index to this day, making it the longest-running constituent of the index.

However, it is not the oldest company in the index. That top spot belongs to DuPont, founded by Parisian chemist Eluthere Irenee du Pont in 1802. DuPont was first included in the index for only one year, from 1924 to 1925. Due to a decline in stock prices, the company was removed from the index. It only managed to return in 1935 and has been part of the index ever since. In contrast, the youngest company in Dow Jones is Cisco, which was founded in 1993. Cisco joined the index in 2009 and is the only component that directly represents the rise of the Internet. Overall, the average age of the companies in the index is 111 years. The most recently added component was healthcare company Amgen, which entered the index in 2020. Since then, the Dow Jones has remained unchanged and, according to the index's board of directors, there is likely to be no change in 2023.

NASDAQ: Technology Index

The top three indexes are rounded out by the NASDAQ, which today represents more than 3,500 technology-focused companies. The NASDAQ index was founded on February 8, 1971 and it is an acronym for the National Association of Securities Dealers Automated Quotations System. Interestingly, this name belongs not only to the index but also to the stock exchange. The index, therefore, actually tracks all stocks that are currently tradable on that exchange.

In its early days, NASDAQ rocked the financial world and is the world's first electronic stock exchange. It revolutionized the way stocks were traded by introducing automated computer systems to match buyers and sellers. This electronic trading system enabled faster and more efficient transactions, which were gradually adopted by other world exchanges.

Moreover, with the NASDAQ, it is important to distinguish which index is being discussed. The NASDAQ Composite Index tracks 3 589 companies that are currently traded on the stock exchange. In the financial industry, when we talk about this index, we usually mean the NASDAQ-100 index. This represents the 100 largest companies on the exchange.

Both indexes are calculated similarly to the S&P 500, i.e. based on market capitalization. Microsoft has the largest representation with a weighting of 13.2%. It is followed by Apple and Amazon. Also in the top ten are Nvidia, Meta, two share classes of Aplhabet, Tesla, Broadcom and PepsiCo.

The index is known for its high proportion of technology companies. The most prominent sectors represented include information technology, biotechnology, software and internet companies. The NASDAQ is characterized by higher volatility compared to other stock indices. Its value can rise and fall rapidly, depending on developments in the technology sector.

In the 1990s, the index experienced a period of strong growth and became a symbol of the dot-com bubble. In March 2000, it reached a then historic peak of more than 5 thousand points. However, it subsequently experienced a dramatic fall and lost more than 75% of its value between 2000 and 2002. Since the crisis, the NASDAQ has gradually recovered. In 2021, it surpassed the 14-thousand-point mark and is still hovering around that level. The average annual return of the index since 1971 has been 10,35 %.

Compared to previous indices, the NASDAQ is clearly the "easiest" to enter. The company must have a market capitalization of at least $550 million and revenue in the previous fiscal year must be at least $110 million. An interesting rule of thumb is that a financial company can never be part of the index. Therefore, all banks, insurance companies and other financial companies are out of luck in the case of this index.