S&P 500

S&P 500 (also known as the Standard & Poor's 500) is arguably the world's most famous stock market index. Think of it as a giant, constantly updated snapshot of the U.S. stock market's performance. It tracks 500 of the largest and most influential publicly traded companies in the United States, from tech titans to healthcare giants and consumer brands. The S&P 500 is a market-capitalization-weighted index, which is a fancy way of saying that the bigger the company's total stock market value, the more impact its price movements have on the index's value. A 1% jump in a mega-company like Microsoft Corporation will move the index far more than a 1% jump in one of the smaller constituents. Because it represents about 80% of the total value of the U.S. stock market, investors, economists, and the media watch the S&P 500 as a primary benchmark for the health of American business and the economy at large.

You might think the index is simply a list of the 500 biggest U.S. companies by market capitalization, but there's a human touch involved. A special committee at S&P Global, the company that manages the index, has the final say. They select companies based on a set of strict criteria to ensure the index is a reliable representation of the market. These rules include:

• Size: A company must have a certain minimum market capitalization.
• Liquidity: Its shares must be easy to buy and sell.
• Profitability: It must have a recent history of positive earnings.
• Sector Balance: The committee aims for a composition that reflects the sector breakdown of the broader economy.

This selection process makes the S&P 500 a curated list of America's leading public companies, not just a raw ranking by size.

The market-cap weighting method is the secret sauce that makes the S&P 500 tick. A company's “weight” is calculated by taking its total market value and dividing it by the total market value of all 500 companies in the index. Imagine the S&P 500 is a team boat. The largest companies like Apple Inc. are the giant rowers at the front, and their strokes (stock price changes) have a huge effect on the boat's speed and direction. The smaller companies are still crucial members of the team, but their individual efforts have a proportionally smaller impact. This means the performance of the top 10 companies in the index often dictates the direction of the S&P 500 for any given day.

For a value investor, the S&P 500 is both a powerful tool and a philosophical challenge. The goal of value investing, after all, is to buy wonderful businesses at prices below their true intrinsic value, not to simply buy “the market.”

This is a classic debate. On one hand, the legendary value investor Warren Buffett has famously recommended that most people who don't have the time to research individual stocks should simply buy a low-cost S&P 500 index fund.

• The Pro Argument: By buying the index, you instantly achieve broad diversification across America's top industries. You own a piece of hundreds of proven, profitable companies and are protected from the catastrophic risk of a single company you picked going bankrupt. It's a simple, effective, and historically rewarding strategy for building long-term wealth.
• The Con Argument: Buying an index is, by definition, an act of accepting the market's current price. You are buying every company—the wildly overvalued, the fairly valued, and the undervalued—all at once. A purist value investor would argue this is the opposite of their craft, which involves diligent research to find specific bargains the market has overlooked. You're buying the haystack, not searching for the needle.

Even if you don't buy the index directly, it remains an indispensable tool for a value investor.

1. The Ultimate Benchmark: The S&P 500 is the hurdle rate for your own performance. If your hand-picked portfolio of stocks isn't consistently outperforming the total return of the S&P 500 (including dividends) over a full market cycle, you should ask yourself if your efforts are truly adding value. It keeps you honest about your stock-picking skills.
2. A Premier Hunting Ground: The S&P 500 is a pre-vetted list of high-quality, stable, and significant businesses. This makes it an excellent starting point for your research. You can screen the list for companies that have been unfairly punished by the market, are trading at a low Price-to-Earnings Ratio, or have fallen out of favor for temporary reasons, potentially unearthing a value opportunity.

• For Most Investors: Owning a low-cost index fund or ETF that tracks the S&P 500 is a cornerstone of a sound investment plan. It's a simple, diversified, and powerful way to participate in the long-term growth of the U.S. economy.
• For Aspiring Value Investors: View the S&P 500 as your main competitor. Your goal is to use your research and discipline to build a portfolio of individual companies that will beat its returns over the long run. Use it as a source of ideas and a measure of your success.