Companies are removed from the S&P 500 Index for four main reasons: merger with or acquisition by another company, restructuring, financial operating failure, or lack of representation. Historically, the most common reason for removal has been merger or acquisition, and the least common reason has been lack of representation.
The Standard & Poor's Index Products / Services Group constantly monitors the capitalization activities of the companies in the 500. Upcoming mergers, acquisitions, and restructurings are analyzed and brought before the S&P Index Committee. The Committee determines the most appropriate action to take for each event. Sometimes it is blatantly obvious that a company must be removed from the Index. In other cases, the effect of a capitalization change is less clear. The continued inclusion in the Index of a post-merger or post-spinoff original company and the possible inclusion in the Index of a spinoff company must be evaluated. As the table below indicates, each situation is unique.
A corporation's inclusion in the Index is not an opinion on its investment merits, but it does include the assumption that it will remain in business. Thus, in cases of bankruptcy, the filing company is removed from the Index and a company in the S&P 500 Index Replacement Pool is added. A candidate in the Replacement Pool is on standby at all times just for such contingencies. In some rare cases, it is not possible to make a preannouncement five days in advance of the change. This situation occurred when JWP, Inc. and Wang Labs, Inc. filed for Chapter 11 and were removed from the 500 with a preannouncement only one day in advance of the change.
The removal of a company from the Index due to lack of representation is less clear-cut. Lack of representation most often involves those cases in which a corporation has declined in size (usually, though not exclusively, because of financial problems) to the point where it no longer contributes much to the price performance of its industry group, let alone the overall Index. It also can include situations where a company no longer meets other criteria for inclusion. For example, the company could be in an industry that has declined in economic importance because of technological obsolescence. It may still be a leading company, but it is no longer in a leading industry. In some cases, restructurings may leave the stock so closely held that the security becomes illiquid. Although companies that have been removed from the Index for lack of representation typically have extremely low market values for extended periods, they are not removed just because of their low market values.
Maintaining the stability of the company population in the S&P 500 Index and keeping an accurate representation of U.S. publicly traded companies in the Index are the primary considerations in managing the Index. Companies are not removed from the Index due to poor stock price performance. Excessive turnover of companies in the Index would affect the statistical validity of the Index as a gauge of overall U.S. stock market performance.
S&P/BARRA Growth & Value Indices [Return to Top]
The S&P/BARRA Growth Index and the S&P/BARRA Value Index, introduced in May 1992, were developed to track the two predominant investment styles in the U.S. equity market. Using an asset class factor model, a method designed by 1990 Nobel Laureate William F. Sharpe, the companies in the Standard & Poor's 500 Index are classified as either growth or value, a distinction that can account for almost 90% of the monthly variation in return of a typical style-tilted investment portfolio. Following Sharpe's methodology, the companies in the S&P 500 Index were split into two mutually exclusive groups based upon a single attribute: price-to-book ratio.
The Growth Index contains the companies with higher price-to-book ratios, while the Value Index contains those with lower price-to-book ratios. Just like the Standard & Poor's 500 Index, the S&P/BARRA Growth and Value Indices are market-value-weighted. The companies are split so that approximately half of the market value of the S&P 500 Index is in the S&P/ BARRA Growth Index and half is in the S&P/BARRA Value Index. Sharpe's research indicates that the typical growth-and-income mutual fund has "an almost perfect balance between value and growth stocks, reflecting an 'S&P 500-like' stance with respect to large capitalization stocks." More companies are classified as value than growth, because growth companies tend to have larger market values.
The composition of the S&P/BARRA Growth and Value Indices is rebalanced semiannually on January 1 and July 1, based upon price-to-book ratios and market capitalizations after the close of trading one month earlier (November 30 and May 31, respectively). The total-return value for each Index is calculated monthly. Historical data going back to 1975 also have been calculated, using the same procedures to screen the actual components of the S&P 500 Index over that period. Closing index values (excluding dividends) have been calculated daily since January 1993 for each S&P/BARRA Index.
Book value is defined as the total of a company's assets (such as plant and equipment, inventories, receivables, and intangibles like goodwill), minus all liabilities. Price-to-book ratios tend to be more stable than P/E ratios or return on equity; however, they can still be used to classify stocks, since they tend to differ for growth companies and value companies. In general, growth companies tend to have high P/E ratios, low dividend yields, and above-average earnings growth rates. Conversely, value companies tend to have low P/E ratios, high dividend yields, and below average earnings growth rates.
There is no one industry-standard definition of either growth or value. Accordingly, it is important to note that the portfolio selection process will arbitrarily (but not capriciously) define each and every stock in the Standard & Poor's 500 as either growth or value. Because the selection mechanism is strictly statistical, the companies assigned to the Growth Index may not necessarily be perceived by the investing public as growth companies. Likewise, many of the companies classified as value stocks are likely to have reputations as growth stocks. In fact, the consumer staples, perceived as defensive stocks, were heavily represented in the Growth Index at the end of 1993, while technology stocks were fairly evenly distributed between the Indices.
What matters is the fact that the stocks assigned to the Growth Index have tended to perform as if they were growth stocks, while those assigned to the Value Index have tended to perform as if they were value stocks. As theory suggests, the Betas on the stocks in the Growth Index tend to be above 1.00, while those in the Value Index tend to be below 1.00.
Many of the stocks change classification at each semi-annual rebalancing. Turnover in the Growth and Value Indices has averaged about 20% per year since 1975, reflecting both changes in the composition of the S&P 500 and changes in the relative price-to-book ratios of the companies in the 500 at the semi-annual index rebalancing dates.
Comparative Analysis [Return to Top]
Statistical data on the Standard & Poor's 500 Index are closely followed by analysts and investors. Using this data, individual company stocks can be compared against their industry peers and against the market as a whole. Three key S&P 500 data items frequently used by professionals are earnings/expected earnings, P/E ratios, and dividend yields. These three indicators provide important clues for investors trying to determine a fair price for a new stock issue. They also are used in statistical screens designed to identify overpriced or undervalued issues.
Earnings are universally recognized as the single most important factor in valuing a company. A company's past earnings growth rates and their stability help to determine the future earnings power of that company. The future earnings power of a company, in turn, is the theoretical basis for a company's current stock price. Determining the future earnings for companies is an extremely important, yet highly subjective, calculation. Consequently, the earnings calculation on the S&P 500 is of great interest to investment professionals. The actual values, both current and historical, are heavily analyzed.
Standard & Poor's uses primary earnings from continuing operations, excluding the results of discontinued operations and extraordinary items, to calculate the earnings per share on the S&P 500 Index. Nonrecurring pre-tax gains and losses are included in the calculation. The earnings numbers on the S&P 500 are reported on a per share basis using indexed numbers.
Earnings data for the Standard & Poor's 500 companies are gathered by the S&P Index Products Group directly from company publications. The aggregate earnings number for the S&P 500, and for each major industry sector as well as for each individual industry group, is determined and divided by its respective Index Divisor. The result is indexed data that can be used on a comparable basis.
Standard & Poor's publishes two types of earnings data on the index. Annual data, based on the timing of each Index company's fiscal year, are published annually in the Analyst's Handbook. Quarterly data, based on quarterly earnings per share recorded during each calendar quarter, are published on a monthly basis in the Analyst's Handbook Supplements. The annual Analyst's Handbook earnings per share calculation uses May 31 as its cutoff date. For all companies with a fiscal year ending during the first five months of the year, S&P used their 1993 earnings per share in the calculation of the 1993 S&P 500 earnings-per-share index number. For companies with fiscal years ending during the last seven months of the year, S&P used their 1992 earnings per share values in the calculation of the 1993 S&P 500 earnings-per-share index number.
Earnings estimates are based on calendar-year data and are computed in three steps: (1) S&P equity analysts estimate earnings per share for all S&P 500 Index companies. (2) Earnings estimates for each company are multiplied by each company's respective shares outstanding to calculate the total earnings number for each company. (3) Total earnings are aggregated for each individual industry group, major industry sector, and the Composite, and divided by their respective end-of-period Index Divisors.
Dividend yields are one of the most widely monitored valuation benchmarks and provide the most tangible form of total investment return. The dividend yield for the Standard & Poor's 500 is an index figure based on the indicated annual dividend rate for each stock in the Index. Historically, since World War II, dividend yields for the S&P 500 have ranged from a low of 2.63% (set in January 1994) to a high of 8.64%. Over the past 30 years, the average has been about 4%. Typically, a yield of 5% to 6% has represented an undervalued market, while a yield of 3% or less has an indicated an overvalued market. At year-end 1993, the dividend yield for the S&P 500 was 2.70%, compared with 1992's ending rate of 2.84%. The main reason for the 4.9% decline in yields in 1993 was that dividend growth did not keep pace with the growth in stock prices during the year.
During the 1990s, dividends paid by the companies in the S&P 500 grew at an annual average rate of 7%, approximately 1 percentage point higher than their long-term trend rate of growth. However, the dividend growth rate has slowed in the 1990s. It was only 1.5% in 1992 and improved minimally to 1.6% in 1993.
The price-earnings ratio (P/E) is a popular indicator used to gauge the price investors are willing to pay for each dollar of a company's earnings. The ratio is generally reported two ways: on the basis of actual 12-month trailing earnings or as a multiple of analysts' projected earnings for the current year.
During the post-war era, the actual P/E ratio of the Standard & Poor's 500 Index has been as low as seven-reached in the late 1940s and again in the 1974-81 period-and has hit a peak of nearly 23-reached in 1961. Just prior to the October 1987 crash, the P/E ratio for the S&P 500 was above 20. The P/E ratio for the S&P 500 Index at year-end 1993 was 21.31 (based on actual trailing 12-month earnings), a decline of 6.62% from the 1992 actual year-end P/ E ratio of 22.82.
Historically, a S&P 500 P/E ratio of 10 or lower has indicated an attractively valued market, while a P/E of 14-15 represented a fairly valued market, and a P/E of 20 and above signaled an overvalued market.
Other Statistical Data
S&P also calculates and publishes additional Standard & Poor's 500 industry group statistical data, indexed on a per share basis, for use in comparative analysis. Per share indexed numbers calculated for income statement items include sales, expenses, operating income, and depreciation. Balance sheet per share numbers calculated include current assets, current liabilities, and book value. These per share numbers are calculated for the major industry sectors as well as each industry group and published in the Analyst's Handbook Annual. In addition, indexed per share cash flow, earnings, dividends, tangible book value, and equity per share data for the Composite Index are calculated and published in the Analyst's Handbook Annual.
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