In this post, we will look at the key differences between the Dow and the S&P 500, but first, here is our disclosure.

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The Barometer of the Economy

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Everyone has heard about the Dow Jones Industrial Average and the S&P 500. You cannot escape them. They are a hot topic when discussing the economy and your investment performance. People’s opinions and emotions on the economy rise and fall with every up and down, and “experts” are waiting to tell you what it all means. Why are the Dow Jones and the S&P 500 given such importance in investing?

The Dow Jones and S&P 500 are stock market indexes that track a large group of companies in the United States across the many sectors of the economy. The companies are chosen using a specific set of criteria, each given a particular weight in their respective index. As a result, they are the barometer of the economy and the benchmarks to which many other investments are compared.

This is where their similarities end and their differences begin.

Gas vs. Electric?

The Dow Jones and S&P 500 are built using different methods, similar to a gas-powered car to an electric one. Both cars get you from point A to point B, but the technology behind how they do that is different.

Suppose you have an issue with your gas-powered car’s battery and bring it to the mechanic. The mechanic would open the hood, locate the small battery, loosen a few screws, and quickly swap the old battery for a new one.

Now think of the shock that same mechanic would have if you brought in your electric vehicle to have the battery replaced. The mechanic would open the hood to find a trunk, not the engine compartment. Confused, the mechanic would send you to a repair shop specializing in electric cars.

The Dow Jones and S&P 500 are similar to the cars in the example above. Both indexes are comprised of companies representing the broader economy, but how they operate and run is not the same.

Let’s dig deeper into the key differences between the Dow Jones and S&P 500.

1. Number of Companies

The most glaring difference is the number of companies that make up each index.

Dow Jones Industrial Average (DJIA)

The Dow Jones Industrial Average comprises 30 blue-chip companies that trade on the New York Stock Exchange (NYSE) and NASDAQ. Blue-chip companies are large, well-established, and stable companies.

The term “Blue-Chip Company” is based on the game of poker. The blue chip is often considered the most valuable. Referring to a company as a “blue-chip” means it is one of the most valuable companies in the market.

The 30 companies in the Dow Jones span the economy’s many sectors and are listed in the table below. You are probably quite familiar with most companies on this list and might even use some of their services or products daily.

IntelWalt DisneySalesforceWalgreens3MApple
MicrosoftNikeVerizonHome DepotCisco SystemsJPMorgan Chase
Goldman SachsAmerican ExpressDowProcter & GambleBoeingVisa
McDonald’sHoneywellWalmartUnitedHealthIBMCoca-Cola
Johnson & JohnsonCaterpillarTravelersAmgenChevronMerck
Dow Jones Industrial Average

The downside to the Dow Jones is that it is limited to 30 companies so it will be missing some of the world’s largest and most influential companies. For example, the Dow Jones is missing Alphabet (Google) and Amazon.

Amazon is both an e-commerce and cloud computing juggernaut. Alphabet owns Google, YouTube, and companies like Waze and Fitbit. These companies have a combined market cap of over $2 trillion, landing them among the top 5 most valuable companies in the United States. Neither is in the Dow Jones.

How can that be? We will get to that later in this post when we discuss weighting.

S&P 500

When you hear reports on the “stock market,” you’re typically hearing about the up and downs of the Dow Jones, but the reality is that the S&P 500 holds a much larger basket of companies.

The S&P 500 index is much more extensive than the Dow Jones and tracks 500 of the largest publicly traded stocks in the United States. It includes all 30 companies in the Dow Jones plus 470 additional ones. This equates to the S&P 500 holding almost 17 times more companies than the Dow Jones. The result is the S&P 500 represents all 11 sectors of the economy across a much wider range of companies.

Not only does the S&P 500 include Alphabet (Google) and Amazon, it does so with each among its top holdings.

If you do a quick search, you will find 503 stocks in the S&P 500. This is due to a few companies having multiple classes of stock listed in the index. For example, Alphabet (Google) has Class A and Class B shares listed separately in the S&P 500.

2. Market Cap

Market cap is short for market capitalization and is the total value of a company’s outstanding stock. So, a company with 10 million outstanding shares trading at $100 per share would have a market cap of $1 billion.

The market cap of an index is simply the total of the market caps of all the companies that comprise the index. As you can imagine, the S&P 500’s total market cap is significantly larger than the Dow Jones, given that it tracks 500 companies instead of 30.

The 30 companies in the Dow Jones have a combined market cap near $10 trillion. That is an enormous number, but the total market cap of the S&P 500 is four times larger, with a market cap of around $40 trillion. That $40 trillion total market cap is mind-boggling, considering it equals the US and China’s GDP combined.

The total market cap of the indexes also puts into perspective the size of the companies in the Dow Jones.

Another way to look at this is those 30 companies in the Dow Jones make up 25% of the total market cap of the S&P 500. Only 30 companies make up 25% of the total market cap of the S&P 500! This is what people mean when they say the Dow Jones is built using large blue-chip companies.

3. Weighting

How the Dow Jones and S&P 500 determine the weight of a company in their index could not be any more different.

Let’s have a look, starting with the S&P 500.

Weighting in the S&P 500

Companies in the S&P 500 are weighted by market cap. The companies with the largest market caps have the most weight, and those with the smallest market caps have the least weight.

You divide a company’s market cap by the total market cap of the S&P 500 to determine its weighting in the index.

The S&P 500 only considers publicly traded shares when determining a company’s market cap, and you will hear this described as “float” or “free float.”

Company’s Weight = Company’s Market Cap / Total Market Cap of S&P 500

Let’s see how this is applied to the largest company in the S&P 500, Apple, and one of the smallest, Domino’s Pizza.

Apple’s market cap is just over $2 trillion, and Domino’s Pizza’s market cap is near $13 billion. If we put the S&P 500 total market cap at $40 trillion, then Apple would have a weighting of 5% ($2 trillion / $40 trillion = .05 or 5%), and Domino’s Pizza would have a weighting of .0325% ($13 billion / $40 trillion = 0.000325 or .0325%).

Weighting by market cap results in Apple having the most weight in the S&P 500, followed by Microsoft and Amazon. As of this writing, these three companies make up close to 15% of the S&P 500’s total market value.

Weighting in the Dow Jones Industrial Average uses an entirely different method, resulting in Apple no longer being the top dog.

Weighting in the Dow Jones Industrial Average

One day you wake up, go outside to start the Dow Jones, and find it is not running correctly. You are having issues with the weighting in the Dow Jones and need to get it fixed. It is 8:30 in the morning, and the Dow Jones needs to be at work in time for the opening bell. In a hurry, you bring it down to the nearest repair shop. The problem is this repair shop only works on the S&P 500.

The mechanic agrees to have a look and opens the hood to find a jumbled mess. The first stocks the mechanic expects to see are Apple and Microsoft but instead is shocked to find UnitedHealth and Goldman Sachs.

How can UnitedHealth and Goldman Sachs have greater weight than Apple and Microsoft? Apple and Microsoft each have market caps of around $2 trillion compared to $450 billion for United Health and $120 billion for Goldman Sachs. What is going on?

Price-Weighted Index

The Dow Jones Industrial Average is a price-weighted index. This means the weight of a company in the Dow Jones is based on its stock price, not market cap.

A special Dow Divisor is used when calculating the price weighting of a company in the Dow Jones. The primary function of this divisor is to keep the index value consistent when there are stock splits and other changes.

Currently, UnitedHealth, near $500 per share, is given the most weight on the index, followed by Goldman Sachs, Home Depot, and McDonald’s.

Apple, the largest company in the world, with a market cap of $2 trillion, finds itself with a weighting that lands it in the middle of the Dow Jones because of its stock price of around $140. Microsoft does not crack the top 5 of the Dow Jones either, even though its share price is over $200.

This approach to weighting an index may seem odd, but remember that the Dow Jones only deals with 30 stocks, not 500. Let’s see what happens if the Dow Jones used the same method as the S&P 500.

In the S&P 500, Apple and Microsoft have a combined weighting of over 12% as of this writing. If the Dow Jones also weighed companies by market cap, they would have a combined weight of almost 40%. Any move in Apple’s and Microsoft’s stock prices would dramatically affect the Dow Jones.

So, using a price-weighted average allows large companies like Apple to be included in the Dow Jones without having an outsized role in the index.

Why are Alphabet and Amazon Left out of the Dow Jones?

Being a priced-weighted index also means companies with sky-high stock prices will never be included in the Dow Jones. This is one reason companies like Alphabet and Amazon were never included in the Dow Jones.

Before their recent stock splits, Alphabet and Amazon each had a stock price of over $2,000 per share. Imagine the impact a company with a $2,000 share price would have on a price-weighted index that only includes 30 companies with stock prices ranging from $30 to $500 per share. They would have had such an outsized weighting that you might as well rename the Dow Jones the Alphabet-Amazon Stock Market Index.

Alphabet and Amazon are no longer trading at over $2,000 per share after they completed 20-1 stock splits in 2022. Their stock prices are much lower now, giving Alphabet and Amazon a chance at joining the Dow Jones, but only if popular opinion agrees.

This leads us to the final key difference and the question: How are companies selected to be included in the S&P 500 and Dow Jones?

4. Selection

It is the middle of winter, and you go outside to start the Dow Jones, but it will not start. You determine a bad battery (company) needs replacing. Desperate to get to work, you bring it down to your local S&P 500 mechanic, as there are no Dow mechanics nearby.

The mechanic goes to her computer for a step-by-step guide on how to replace the bad company. She cannot find anything. There are no step-by-step guides, no videos, nothing.

Once again, the S&P mechanic is stumped. Regarding the S&P 500, there are step-by-step guides on how to make each repair. How can the mechanic fix the Dow Jones without any repair guides?

S&P 500 and the Structured Approach

The S&P 500 uses a well-defined method with a final review process to ensure the index’s composition aligns with the broader economy. Here is a quick look at some of the selection criteria used to determine if a company can be included in the index:

Large: A company must meet a fluctuating minimum market cap threshold, currently near $12 billion.

Publicly Traded: Most of a company’s stock is held by the public and traded on stock exchanges.

Trading History: Needs to have a minimum of 12 months trading on a major exchange

Profitable

US Companies

Committee Approved: A committee has final approval

As you can see, the S&P 500 takes a quantitative approach when choosing the companies included in the index. On the other hand, the Dow Jones Industrial Average takes a qualitative approach. So, what does this method look like?

The Dow Jones Popularity Contest

Unlike the S&P 500, the Dow Jones does not have a long list of criteria a company must meet to be considered in the index. The only rule is that a company must be in the S&P 500, not a transportation or utility company. That’s about it.

So how does a company get selected?

I liken it to a popularity contest. If a company is big and popular with a stock price that is not too high, then it has a chance to make it into the Dow Jones. Why?

Because a tiny group of people on a committee from the Wall Street Journal and S&P Global decide on what companies to include and who to kick out. This committee ensures companies in the Dow Jones align with the economy. After reading this paragraph, you might be ready to brush the Dow Jones aside but don’t.

With 500 companies, you need a much more rigid set of rules to determine who is in or out—only having 30 companies changes that dynamic. Remember, the Dow Jones has two major limiting factors: it can only contain 30 companies, and there is a ceiling on the stock price of those companies.

How could you create a set of quantitative criteria to narrow a list that starts near one thousand large-cap companies down to 30? It would only get you so far before someone must decide who is in and who is out. That someone is the Dow Jones committee.

Conclusion

Comparing the Dow Jones and S&P 500 is similar to comparing gas-powered cars to electric ones. Both indexes represent the broader economy, but how they are built differs.

We saw this by examining four significant differences between the Dow Jones and S&P 500. The two are pretty different, from the number of companies each includes, to how they select these companies and give them weight. Even though we focused on their differences, I hope you can now see why both indexes are highly regarded.

Ultimately, the Dow Jones and S&P 500 take vastly different approaches when building a stock market index, but the destination is the same. The result is both are considered top stock market indexes representing the broad US economy.