Question

The Dow and the S&P 500 have very different criteria in which to include companies in their index. Is high share price one of these criteria and describe?

Answer 1

A) For a company to be included in S&P 500, it must have the following:

1. A market cap of $5.3 billion
2. Its headquarters in the U.S.
3. The value of its market capitalization trade annually
4. At least a quarter-million of its shares trade in each of the previous six months
5. Most of its shares in the public’s hands
6. At least half a year since its initial public offering
7. Four straight quarters of positive as-reported earnings.

As from above points 2,4,5,6 & 7, it's clear high share price is not accounted for. Now lets concentrate on point 1 & 3 in above which talks about Market capitalization. Market capitalization (market cap) is basically the market value of a publicly traded company's outstanding shares. It is basically equal to the share price multiplied by the number of shares outstanding. As you can see even if share price is high but outstanding shares are less( and vice-versa), then it won't meet the requirements of point 1 which is market cap of $5.3 Billion since the calculated market cap(share price multiplied by the number of shares outstanding) will be less than the required market cap. This concludes that high share price of a company is not of the criteria to be included in S&P 500.

B) The Dow components are chosen by S&P Dow Jones Indices, and there are no specific rules for inclusion. Generally speaking, components of the Dow should be large and respected companies. However, they aren't the 30 largest companies in the market (a common misconception). It tracks 30 large-cap blue chip U.S. companies that are, for the most part, household names – including giants like Apple, Coca-Cola, Disney, Microsoft, Nike and Visa. Therefore High share price again is not a criteria to be included in Dow, however it does have a significant impact in calculating Dow Jones Industrial Average.

The Dow Jones Industrial Average is a price-weighted index, which means stocks with higher share prices are given a greater weight in the index. Instead of dividing by the number of stocks in the average, as is done in an arithmetic average, the sum of the component stock prices is divided by a special divisor. The purpose of this Dow divisor, which is continually adjusted, is to smooth out the effects of stock splits, dividends paid or corporate spin offs; this allows for a consistent index, keeping the Dow from getting distorted by one-time events. The result is the DJIA is affected only by changes in the stock prices, and stocks with a higher share price have a larger impact on the Dow's movements.

Hence high share price is not a criteria for a company to be included in Dow, however it does affect the Dow Jones Industrial Average.