What Is a Constituent?

What Is a Constituent?

A constituent is a company whose shares are part of an index such as the S&P 500 or Dow Jones Industrial Average (DJIA). It is a component or a member of an index. The weighted aggregation of the share prices of all its constituents is used to calculate the value of an index. Each constituent must typically meet certain market capitalization, market exposure, and liquidity requirements before being added to an index.

Understanding Constituents

Constituents are individual components that make up the market indexes in the United States, including the DJIA, the S&P 500, the Nasdaq Composite Index, and the NYSE Composite Index, among several others, For instance, the DJIA, which was established as a simple average of stock prices in 1896 by Charles Dow, is made up of shares of thirty large companies.

Indexes serve important functions. This includes tracking the performance of particular markets or sectors and providing investors and portfolio managers with benchmarks to evaluate their performance. The S&P 500 Index is considered to be the benchmark for stock market investors for relative performance. It's also the benchmark for a fund manager who consistently outperforms the index or beats the market.

By gaining entrance into a market index, a constituent stock or company receives the benefit of increased exposure and a certain amount of credibility. It can also boost the share price because many passive index funds attempt to track the S&P 500 and other indexes. When a company becomes a constituent, these funds must buy shares and the buying demand can create an S&P 500 phenomenon called the index effect.

Requirements of Constituents

The criteria for being a constituent of a market index varies from one index to another. But, there are three different ways that indexes are built, which are highlighted in the table below:

The DJIA is weighted by price. It is comprised of well-known companies that span many industries. The weight of each constituent on the index is proportional to its price. A committee at Dow Jones determines which companies come and go within the industrial average.

The Nasdaq Composite Index and NYSE Composite Index track the performance of all equities listed on each stock exchange. The weight that each constituent has on the overall index is based on market capitalization, with both the price return and dividend yield of each constituent factoring into movements of the index.

The S&P 500 is another example of a market value-weighted index and the largest companies have the biggest impact on its performance.

Example of Constituents

The DJIA is a stock market index that tracks 30 large, publicly-owned blue-chip companies trading on the New York Stock Exchange and the Nasdaq. The index is often re-evaluated to replace companies that no longer meet the listing criteria with those that do. Below is the current list of Dow Jones constituents:

The Bottom Line

Market indexes represent different segments of the financial markets. Some of the world's largest indexes include the Dow Jones Industrial Average, the S&P 500, and the Nasdaq Composite Index. Each index is made up of constituents or individual companies. Each index has its own set of requirements that constituents must meet to be listed. These include market cap, exposure, and liquidity. The benefits of being listed as an index constituent include greater exposure and credibility.