Wednesday, March 17, 1999
What is an index?
BY URSULA MILLER
The Cincinnati Enquirer
An index is a representative sample used to measure changes in a large group or population.
In the case of stocks, the population is the market and there are myriad ways to slice and dice the market.
MAJOR U.S. STOCK INDEXES
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Dow Jones Industrial Average
Established in 1896; refined in 1928
Covers 30 U.S. large-company stocks traded on the New York Stock Exchange
Tuesday's close: 9930.47 Standard & Poor's 500 Index
Established with base value of 10 for the period between 1941-43
Made up of 500 of the largest U.S. company stocks
Tuesday's close: 1306.36 Nasdaq Composite Index
Established with base value of 100 as of Feb. 5, 1971
Covers more than 5,000 stocks, many of them technology issues. Home to the largest U.S. company, Microsoft Corp., based on market capitalization.
Tuesday's close: 2439.27. Russell 2000 Index
Established with base value of 135 as of Dec. 31, 1986
Made up of the smallest 2,000 companies in the Russell 3000 Index. Range in market capitalization: $221.9 million to $1.4 billion
Tuesday's close: 399.17
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The Dow Jones Industrial Average, for example, measures changes in the stock prices of 30 of America's largest companies.
Investors use indexes as benchmarks. Besides the Dow, the two most commonly quoted stock indexes are the Standard & Poor's 500 and the Nasdaq Composite.
“It's called a benchmark because it's truly a measure that an investor uses to compare himself to the market or to a particular segment of the market,” said Gary Holt, product manager for indexes at the money management consulting firm Frank Russell Co. in Tacoma, Wash.
Indexes typically express changes in point or percentage terms, with members most often ranked by size or market capitalization.
As the stock market has grown and become more complex, so too, have indexes. Today there are thousands of indexes that measure stock price performance based on industry or economic segment, geographic locale or a company's size.
The bigger, broad indexes such as the S&P 500 even have sub indexes that look at the performance of certain industry sectors within it.
But indexing was a unique concept when Charles Dow began developing what would become the Dow Jones Industrial Average. The stock market also was much smaller, with only a few hundred stocks by the turn of the century. The Dow grew in its early years, from 11 initial members to 12, then 20 and 30 by the late 1920s.
There is no rule that limits the number of companies in the Dow but tradition has kept membership at 30.
By World War II, the Standard & Poor's Corp. saw the need for an index with a broader representation of U.S. stocks.
“That's where the S&P 500 came in a number of years ago, as a much more complete representation of the market,” Mr. Holt said. “It didn't get up to 500 stocks until the late 1950s.”
Today, the S&P 500 is arguably the benchmark most widely used by professional money managers, certainly more so than the Dow. It represents nearly 75 percent of total market capitalization for U.S. stocks.
By the early 1970s, a completely new type of stock market that used a computer network rather than a physical floor for trading was launched — Nasdaq. The Nasdaq developed its own index, the Nasdaq Composite, to measure the performance of stocks on its electronic “exchange.” The Nasdaq Composite includes more than 5,000 stocks today.
The Frank Russell Co. developed a new series of even broader indexes in the mid-1980s. The Russell 3000 covers 98 percent of total U.S. market capitalization, Mr. Holt said. The Russell 2000, a subset of the Russell 3000, is generally used as a proxy for the performance of small company stocks.
Market experts in the 1990s are are developing and refining international stock indexes to measure the performance of stocks globally.
“The big trend after the fall of the Berlin Wall and communism (in the late 1980s) has been the growth in the Third World markets,” said Declan O'Sullivan, a native of Ireland and a partner at money manager O'Sullivan & Sims downtown.
One of the oldest benchmarks for measuring developed markets abroad is Morgan Stanley Capital International's “EAFE” index, which stands for Europe Australasia and Far East.
No one true international index, though, has gained universal acceptance because of the problems that occur when combining the stocks of volatile emerging countries with those of more stable developed countries.
“I really couldn't say there's one that does the best job for the most people. I like the Morgan Stanley Capital International All-Country Ex-US Index,” said Madelynn Matlock, manager of the Bartlett Value International Fund in Cincinnati.
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