Last week, the S&P 500 hit 4,000 for the first time in history, causing the financial pundits to trip over themselves with glee. In December last year, the Dow hit 30,000 and my blog post answered a few questions swirling around what that even means to the average person. So, not to be outdone by my own self, I digress this week on what is the S&P 500, and what does 4,000 mean? And, more importantly, does it even matter?
The S&P 500 (officially the Standard & Poor’s 500) is a market-capitalization weighted index of the 500 largest publicly-traded companies in the U.S. Market capitalization? Weighted? What is this witchcraft! Well, as we discussed in the Dow 30,000 post, the value of the Dow is calculated by simply adding together the stock prices of the 30 companies included in the index (and then dividing by a factor to adjust for stock splits). This is a bit clunky, in that a very small and meaningless company in the Dow (ever heard of Travelers Companies?) might have a super high stock price. Whereas a very large and meaningful company (think Microsoft) may have a small stock price.
Hence, a market cap weighted index seeks to solve for this problem. Market capitalization is calculated by multiplying the total number of a company’s outstanding shares by the current market price of one share. To wit, Microsoft has a crap ton of shares available to trade (7.61 billion shares for those keeping score at home) x $250.50 per share (as of 4/7/2021) = a market cap of (drum roll)…$1.90 trillion. Holy crap that’s a lot! Now, let’s look at Travelers Companies: 253.5 million shares outstanding x $151.81 per share = $38.48 billion market cap. Microsoft = big company. Travelers = small company. So, the S&P 500 gives a larger weighting to Microsoft’s share price than Travelers share price. This translates into the price movement of Microsoft having a 5.12% impact to the index, whereas Travelers has a 0.12% impact to the index (as of 3/31/2021).
Whew! Are you kidding me Tony! This is too technical! I can literally hear my readers nodding off as if they were listening to a boring sermon. But, allow me another paragraph or 2 to answer the question I began this post with…does S&P 4,000 even matter? Is the market too hot? Will it fall like a house of cards?
Stocks represent the ownership of a business. The overwhelming vast majority of companies are intelligent, profit seeking businesses, run by remarkably capable professional managers for the benefit of the shareholders. These managers are tasked with enhancing shareholder value over time.
Every day, 7.5 billion people wake up and make economic and financial decisions in their own best interests. Says one, “I need food today.” Says another, “I need gas for my car.” Says yet another, “A latte sounds really good today.” These companies respond to those buying impulses and signals by creating products and services to meet the needs of humankind. Hence, they gather more revenue, employ more people, innovate new products and services, generate more profit and the flywheel spins onward.
If you think about it, stocks are a great mechanism to fully capture human ingenuity. And those who risk their hard-earned money to invest in them, despite the sureness of short-term swings, will be rewarded richly in the long run.
S&P 4,000. We’ve celebrated you. Time to move on.
S&P 5,000…here we come!