The Dow Jones Industrial Average (DJIA, or Dow), the S&P 500, and the Nasdaq Composite Index are three stock market indexes that you’ve undoubtedly heard about. All three indexes are used to evaluate market performance on any given day. They’re also used to calculate a variety of investment products that are based on daily price changes.
The Nasdaq Composite, the S&P 500, and the Dow have three major differences. The first is their coverage universe, which includes many different sectors. The Nasdaq Composite and S&P 500 are larger indexes that include more firms in various industries than the Dow does.
The second distinction is the way the Nasdaq Composite and S&P 500 use market capitalizations (market caps) to weight individual firms in their indexes. The DJIA, on the other hand, assigns a weight to each stock based on its price.
The criteria used to choose index constituents differ significantly. The Dow, for example, is more value-oriented than the Russell and NASDAQ; it employs a combination of quantitative and qualitative data to decide whether a certain stock should be included in its index, as opposed to the other two.
The S&P 500 is a market-cap weighted index of large-cap stocks, like the Nasdaq Composite. It has 500 component firms from many different businesses that span across several sectors and industries. The S&P and MSCI developed the Global Industry Classification Standard (GICS), a worldwide classification system for firms, in 1999.
The S&P 500 is considered a more accurate reflection of the market’s performance across all sectors than the Nasdaq Composite and the Dow. The disadvantage of having many sectors in the index is that, relative to the Dow, the S&P 500 is more volatile. As a result, its increases may be greater on days when the market does well and losses greater on days when it falls.
To be included in the S&P 500, a firm must meet determined quantitative criteria. These include having a market capitalization of more than $11.8 billion, a public float of at least 10% of shares, and four quarters of earnings that are positive. As of Dec. 10, 2021, the S&P 500 has attained an all-time high of 4,712.02.
The Nasdaq Composite Index was established in 1971 and is the oldest exchange-traded index in the world, with a starting value of 100. Almost all firms listed on the Nasdaq stock market are included. In fact, to be eligible for inclusion into the index, a company must have a listing on the exchange.
The Nasdaq Composite is a capitalization-weighted index, meaning that it assigns weights in proportion to the market caps of the respective firms. The composite’s performance reflects that of the exchange as a whole, which reveals how well the technology sector is performing.
This is due to the fact that the sector accounts for roughly 50% of the index’s total composition. According to research conducted in December 2021, the top 10 firms tracked by the index were technology giants, who accounted for 44.8% of the overall weight of the index.
As the tech sector’s prominence has increased, the Nasdaq Composite’s value has leaped. For example, on March 9, 2000, when the dotcom bubble engulfed technology stocks at the turn of the century, the Nasdaq Composite rose to 5,046.86.
Between 2008 and 2012, the Nasdaq Composite Index experienced a period of rapid growth. In May 2012, after eight years of expansion and over 1,000 percent advance in value, it fell by more than 4,000 points in just a few months. It took 15 years to recover those losses and another four to reach 5,000 again.
The rise in stock prices following the pandemic’s outbreak once again boosted tech valuations in 2021, when the index reached an all-time high of 16,057.44 on November 19th.
The Dow Jones Industrial Average (DJIA) was established in 1896 with 12 members and is the oldest of the three indexes. With only 30 constituents, the Dow—as it is popularly called—also has the fewest members. The Dow is a price-weighted, large-cap index, meaning that its overall value is determined by the daily stock price of its constituents.
Thus, a stock with a high price will have a disproportionately big impact on the Dow’s value. The Dow is considered a blue-chip index because it tracks the performance of key companies that are household names and are supposed to comprise a subset of the American economy.
But it is not comprehensive. For example, there are no utilities or transportation companies in the Dow. (They are tracked by the Dow Jones Utility Average and the Dow Jones Transportation Average.) As of December 2021, the Dow covered equities in nine sectors ranging from information technology (IT) to energy and financials.6
The selection criteria for the Dow are a mix of quantitative and qualitative factors. Thus, it includes companies that have a sterling reputation in their respective industries and have a history of generating profits over the long term.7 The emphasis on qualitative factors restricts the number of companies that can become members of the index. In contrast, the Nasdaq Composite and the S&P 500 have a bigger coverage universe that attempts to cover many companies in different sectors.
The Dow’s selective makeup means that it is not always an accurate gauge of the stock market’s performance or of the U.S. economy. For example, in a rising market, there might be instances when investors rotate out of established names into growth stocks that may not be represented in the index. During such periods, the S&P 500, which includes more companies, will have higher gains than the DJIA will. The Dow closed at an all-time high of 36,432.22 points on Nov. 8, 2021.
The market valuations of all three sectors are highly interconnected. As a result, they move in tandem. However, the degree of growth or decline varies from index to index. The decision to invest in a particular index is determined by your strategy and objectives.
Choosing an index isn’t a zero-sum game, but there are limits. All three offerings include numerous equities. This is especially true for companies from growing industries.
The indexes produce different individual returns, despite mirroring each other’s price movements, based on the economy and market conditions. Here’s a scenario to demonstrate: In the 2010 bull market, the DJIA rose 11% compared to the 12.8 percent gain for the S&P 500.
Meanwhile, the Nasdaq Composite rose 17% on the back of a strong year for the tech sector, which accounted for most stock market performance.
The higher figure for the S&P 500 in 2010 was primarily due to a greater number of small stocks, which attract cash flow during stock market booms, in the index. However, because there are more tiny stocks than large ones, when the stock market falls and investors flee to blue-chip names on Wall Street’s Dow Industrials, the S&P 500 loses value.
There are three main points of difference among the S&P 500, the Nasdaq Composite, and the Dow Jones Industrial Average (DJIA, or Dow): the criteria that they use to include stocks, their method of assigning weightings to constituents, and their coverage universe.
The Dow’s valuation method differs from that of the Nasdaq Composite and the S&P 500. The Dow uses a price-weighted approach, whereas the Nasdaq Composite and S&P 500 utilize a market capitalization (market cap) weighting system. In comparison to the Nasdaq Composite and S&P 500, the Dow has a broader coverage space and larger coverage universe.
One index may deliver higher returns than other indices in certain situations. For example, the S&P 500 can generate greater gains in rising markets compared to the Dow due to the inclusion of more sectors and small-cap stocks in its portfolio.
During recessions, on the other hand, investors flock to the secure haven of established corporation stocks with proven business models and regular payouts.
The stock price is used to weigh the index in a price-weighted index. As a result, a stock with a high trading value will be weighted heavier than one with a lower trading value. A stock’s market capitalization has an impact on its weighting in a market cap-weighted index, even if the two stocks have equal daily prices.
The S&P 500, the Dow Jones Industrial Average, and the Nasdaq Composite are three major market indices that track performance. Despite their distinct pedigrees, inclusion criteria, and sectoral makeup, the indexes tend to move in tandem.
One index may outperform the others depending on the state of the economy and stock markets. The S&P 500, for example, can produce greater returns than the Dow in rising markets due to the inclusion of more sectors and small-cap stocks in its portfolio.
Investors flee equities in a downturn when the market is too unstable for them to feel confident about their investments, and they seek refuge in the safe haven of well-established firms with established business models and regular payouts.
Have any questions or comments? Write them below!