Understanding the Differences Between SP 500 and SP 500 Growth Indexes

The SP 500 and the SP 500 Growth Indexes are both stock market tools used to track the overall performance of the U.S. equity market, but they serve different purposes and focus on distinct segments of the market. Below, we explore these differences and how they might impact investor decisions.

SP 500 Overview

Definition: The SP 500 is a market-capitalization-weighted index consisting of the 500 largest publicly traded companies in the U.S. This index serves as a broad representation of the American economy, reflecting its diverse industries and sectors.

Composition: This index includes companies across various sectors, such as technology, healthcare, financials, and consumer goods. The market-capitalization-weighted nature of the SP 500 means that the largest companies have a greater influence on the overall index performance.

Purpose: The SP 500 is widely used as a default benchmark for overall market performance. Investors and analysts use it to compare the performance of individual stocks, portfolios, and other financial instruments against a standardized benchmark.

SP 500 Growth Index Overview

Definition: The SP 500 Growth Index is a subset of the SP 500 that focuses on companies identified as growth stocks. These are companies expected to expand at an above-average rate compared to the overall market.

Composition: The SP 500 Growth Index typically includes companies with higher price-to-earnings (P/E) ratios and higher earnings growth rates. Sectors like technology and consumer discretionary are often represented strongly in this index.

Purpose: Investors who are looking for stocks with potential for above-average growth often prefer the SP 500 Growth Index. This index is designed to highlight companies that are expected to grow faster than the overall market, often at the expense of current profitability.

Key Differences

While both indexes are rooted in the broader U.S. market, the SP 500 provides a broader representation of the economy, encompassing companies from various sectors. In contrast, the SP 500 Growth Index narrows its scope to focus on companies with high growth potential. Investors might choose between these indexes based on their investment strategies, risk tolerance, and market outlook.

For example, the SP 500 is an excellent choice for investors seeking a diversified portfolio that reflects the overall US economy. On the other hand, the SP 500 Growth Index is suitable for investors who are willing to take on higher risk in pursuit of greater growth potential.

Understanding Market Style: Growth vs. Value

Market style categorization is another important aspect to consider when evaluating these indexes. Stocks are generally segmented into 'growth' and 'value' categories based on their characteristics and performance.

Value Stocks:

Tend to be more mature and cyclical, with established market positions. Are often financially sensitive, influenced by factors such as interest rates, commodity prices, and economic cycles. Examples include financial stocks, energy, utilities, and heavy manufacturing companies like banks, energy providers, and large car manufacturers. Generally perform well during the early stages of an economic expansion.

Growth Stocks:

Have the capability to expand, remake, or redefine their markets through innovation. Are often independent of traditional economic factors like interest rates and commodity prices. Represent sectors such as technology, pharmaceuticals, biotech, and consumer products and services, including web commerce and media. Tend to perform better during the later stages of an economic expansion.

The dominance of either growth or value stocks can shift over time. During the current economic expansion, growth stocks have been favored. However, in the last economic expansion (2001-2007), value stocks led. This volatility in market styles underscores the importance of considering these factors in asset allocation.

As such, when devising an asset allocation strategy, investors often distribute their investments across various categories, including large and small companies, growth and value stocks, and foreign developed markets. The SP 500 is roughly 50/50 growth vs. value, while the SP 500 Growth Index represents just the 250 or so growth-oriented companies within the larger index.

To observe the relative behavior of these indexes, one can compare the performance of two ETFs: SPYG/IWF for SP 500/Large Company Growth, and SPYV/IWD for SP 500/Large Company Value.

Conclusion

Both the SP 500 and the SP 500 Growth Indexes are valuable tools for investors, each catering to different investment needs and strategies. By understanding the unique characteristics of each index, investors can make more informed decisions and construct portfolios that align with their goals and risk tolerance. Whether you are looking for a broad representation of the U.S. market or a focus on high-growth potential, these indexes provide essential insights into the dynamic world of stock market investment.