Monday, February 2, 2015

Deconstructing the S&P 500

Deconstructing the S&P 500: How 36 Stocks Gave You 55% of the S&P's Return in 2014

Like a lot of investors, I watched the S&P 500 Index do very well in 2014, especially compared to holdings in small caps, international, and emerging markets. We own the S&P 500 index as a holding and I'm happy about that.  However, I couldn't help wonder how the S&P did so well. The pundits were decrying the death of active management, and new records on the S&P fell daily as the rest of logical investments sat relatively idle. So, I worked out a trusty spreadsheet with help from friends at Highland Capital, and deconstructed how the S&P did. The results are startling: 36 stocks out of 500 provided over 55% of the total return.

Knowing what the S&P 500 is made up of is important. Essentially, it is an index of 500 stocks selected by the S&P US Index Committee. It's not-contrary to popular belief-the 500 biggest US stocks. The S&P 500 is based on market capitalization, so a big company occupies a much larger portion. Apple, for example, is one stock out of 500, or 0.2% of the total number of stocks, but it is 3.25% of the weight of the index. Apple's return has a very big effect on the overall S&P return (more on this in a minute). WPX Energy is another stock in the S&P 500, but makes up only 0.0058% of the Index. The bigger the company, the more it affects the index and, subsequently, how it performs. Southwest Airlines was the best performing stock in the S&P 500 last year (low oil prices helped, and I suppose they save big on meals), but its only 0.11% of weight of the S&P, so it's 126% return only added .73% to the S&P's total return.

Now for the deconstruction:
  • The top 36 stocks in the S&P 500 provided over 55% of the total return of the S&P for 2014.
  • The top 5 stocks (Apple, Microsoft, Berkshire Hathaway, Intel and Wells Fargo) contributed almost 20% of the total return of the index.
  • Apple by itself contributed 8% of the total index return for 2014, while Exxon contributed a negative 1.17%. Apple contributed almost a third of the total amount from all technology stocks.
  • 35% of the stocks made all of the return for the year.
  • Real estate is only about 2% of the S&P 500, but provided 4.25% of the total return.
  • Energy was an obvious drag.
What's the moral of the story? We all know that diversification is key, but this review should be enlightening.

You only needed 35% of the S&P 500 to get all of your return, but which 35%? It reminds me of a story attributed to John Maynard Keynes, who was asked how many stocks you needed to own. His response was "One".  The interviewer then asked "Which one"? Keynes replied, "The one that makes the most money." The interviewer then asked, "How do I find that one?" Keynes' famous response: "Wish I knew!" So for 2014, you may have loved Apple, but you were really happy with Southwest Airlines (+126.3%). You were probably unhappy with Transocean (-59.9%). But if you owned the whole basket, you owned them all. It's the concept of diversification: have parts of the whole world, and enough to make sure you own the winners.