The Nasdaq composite index is a stock market index made up of nearly all of the more than 2,500 stocks listed on the Nasdaq Stock Market, one of the largest and most trusted stock exchanges in the United States. The index lists stocks that represent non-financial companies across various sectors and also lists limited partnerships, real estate investment trusts, and American depository receipts.
To maintain a listing on the Nasdaq, publicly traded companies must meet a number of listing requirements. These requirements include, but are not limited to, adequately timely SEC filings, the maintenance of a minimum price per share of $1, the maintenance of at least $2 million in shareholder equity, and a minimum of 100,000 shares held by the public (also known as public float).
As one of the largest stock market indexes in the world, including companies of all sizes from small-cap to large-cap, the Nasdaq index is often used by investors as a benchmark to compare their portfolio returns to. This is especially the case among technology investors, as almost 50% of the Nasdaq stock exchange and market index is made up of technology companies.
History of the Nasdaq
Founded in 1971, the Nasdaq composite index is the youngest of the “big 3” indexes in the United States, but its shorter history is no reason to discount its validity or its tremendous growth since its inception.
In fact, when the Nasdaq was founded, it traded at just 100 points. Today, the index trades at around 15,000 points. As with any stock market index, the Nasdaq composite index has had its fair share of ups and downs throughout history.
As the technology sector evolved and took shape to become what it is today, the index saw relatively slow and steady gains from its inception until July of 1995, when the index broke the 1,000-point mark for the first time. Three years later in 1998, the index doubled, breaking 2,000 points for the first time.
The accelerating gains continued, inflating what is now known as the dot-com bubble. By mid-March of 2000, the dot-com bubble reached its peak, and so did the Nasdaq. At the close on March 10, 2000, the index peaked at 5,132.52 before tumbling dramatically.
As the dot-com bubble popped, stocks in the technology sector realized incredibly painful declines. As the most tech-heavy of the large-scale United States indexes, the Nasdaq also experienced dramatic declines.
By April of 2000, the index had already fallen nearly 2,000 points to close at just above 3,000. These declines would continue for 2 1/2 years, leading the index down nearly 80% from its March 2000 peak.
In September of 2002, the index finally found support at a level of around 1,200 points. For the next five years, it saw slow yet steady gains, bringing it to around 2,700 points by September of 2007.
Unfortunately, subpar lending practices at this time led to home loans being defaulted on left and right. The strain in the United States real estate market led to a global economic crisis called the Great Recession, which lasted from 2007 to 2009. By February of 2009, the Nasdaq had fallen to just above 1,400 points.
Throughout the next decade, the index experienced incredibly strong gains, growing from Great Recession lows to over 9,700 points. The Nasdaq took a short-term dip as the COVID-19 pandemic started to spread around the world, falling below 8,000 points by mid-March of 2020.
By June 2020, the index had recovered these losses, growing to break through the 10,000 point barrier. Many attribute the gains in the Nasdaq to excitement surrounding biotechnology companies that are working on COVID-19-related vaccines, treatments, and tests, the vast majority of which are listed on the index.
Assets in the Nasdaq Composite Index
The Nasdaq composite index is made up of a wide range of financial instruments. Aside from common stock, the index also lists American depositary receipts (ADRs), limited partnership interests, ordinary shares, real estate investment trusts (REITs), shares of beneficial interest, and tracking stocks.
Regardless of the type of financial instrument, in order to be eligible for inclusion in the Nasdaq composite index, U.S. securities must trade exclusively on the Nasdaq Stock Market. However, listed securities don’t always operate in U.S. markets. In fact, it’s the international nature of the index that sets it apart from some of its largest competitors on Wall Street, including the S&P 500 and Dow Jones Industrial Average.
Another factor that sets the Nasdaq apart is that, while the index covers several sectors, it’s extremely tech-heavy. As of November 1, 2021, technology-related securities made up about 49.83% of the total value of the index. The rest of the Nasdaq index is made up of:
- Consumer Service. Securities in the consumer service sector make up about 16.64% of the total value of the index.
- Health Care. Securities in the health care sector make up approximately 8.94% of the total value of the index.
- Consumer Goods. Consumer-goods-related securities make up about 8.57% of the value of the index.
- Financial. Financial-related securities make up about 7.47% of the total value of the index.
- Industrial. Industrial-related securities make up approximately 5.94% of the total value of the index.
- Other. Finally, securities associated with sectors including utilities, telecommunications, oil and gas, and basic materials make up less than 1% of the total value of the index each.
The securities listed on the Nasdaq composite index are weighted based on market capitalization. This means that every time a security listed on the index sees a price change, its market cap changes and so too does its weight within the index.
In order to be listed and maintain a listing on the Nasdaq composite index, securities have to meet several criteria, known as Nasdaq Listing Standards. These include:
- Earnings. First and foremost, companies must be earning money. In particular, companies must have pretax earnings in the prior three years of at least $11 million. Companies must also have generated earnings of at least $2.2 million in the last two years. Finally, Nasdaq requires that no net losses were reported in any single year during the past three years.
- Market Capitalization. The market capitalization of the security — the total value of all its outstanding shares — must be at least $160 million over the past 12-month period and must not have dipped below this threshold in any of these 12 months.
- Revenue. Companies represented by listed securities must have generated a minimum of $110 million in revenue in the previous fiscal year.
- Free Cash Flow. Listed securities must have a minimum aggregate cash flow of $27.5 million for the past three fiscal years. Also, companies must not have any negative cash flow in any of those three years.
While these listing standards are somewhat strict, some of them can be overlooked as long as other listing criteria are met. These exceptions to the rule include:
- Elimination of Free Cash Flow Requirements. If a company has maintained an average market capitalization of at least $850 million during the past 12 months and generated at least $90 million in revenue during the previous fiscal year, the minimum cash flow requirement is eliminated.
- Elimination of Cash Flow and Revenue Requirements. Companies can eliminate free cash flow and revenue requirements by displaying strong asset values and shareholder equity. Companies with assets having a total value of at least $80 million and stockholders’ equity of at least $55 million are not held to the revenue and cash flow requirements. In addition to the alleviation of cash flow and revenue requirements, the market capitalization requirements for these companies are reduced to $160 million.
Not only does the Nasdaq require the above listing standards to be met in order for securities to be listed within the index, these securities must maintain these listing standards. Compliance teams consistently review securities for compliance with listing standards. Should a security fall short of these standards, it is removed from the index.
How to Use the Nasdaq Composite Index
Investors, economists, and financial professionals of all types often use the Nasdaq composite index in their work. Some of the most common uses for the index include:
1. As a Benchmark
The Nasdaq composite index can be used as a benchmark to compare the returns in your portfolio to. This is especially the case if your portfolio is tech-heavy, as is the Nasdaq. If you’re investing heavily in the technology sector, and your returns don’t meet or beat the returns seen by the index, it may be time to restructure your portfolio to achieve higher returns.
2. As an Investment
The technology sector consists of some of the largest, most secure companies in the world. Names like Apple, Facebook, Amazon, and Alphabet all live and breathe within this sector. Many investors see index funds and exchange-traded funds (ETFs) centered around the Nasdaq as a strong investment opportunity.
Moreover, with assets outside of the technology sector comprising about half of the Nasdaq, tech investors see the index as an opportunity to gain exposure to other sectors while maintaining their focus on tech stocks.
Taking this a step further, if you’re looking to invest in only large-cap stocks on the index, consider investing in Nasdaq 100 index-centered ETFs, which invest in the top 100 most valuable stocks on the index.
3. As a Performance Indicator
Those who take a more technical approach to investing often look for correlations between assets to predict future movement. Using a measurement known as the beta coefficient, investors can use numeric values to measure these correlations. If a stock or other asset is known to move in direct correlation with the Nasdaq composite index, it has a beta of 1. A beta of 0.5 means that there is about a 50% correlation between the two assets. This information can be valuable for investors who look for correlated assets to purchase together in an attempt to expand gains.
4. For Economic and Market Monitoring
The Nasdaq has also been a great gauge of economic and market conditions since its inception. When economic conditions are poor in the United States or on the global stage, we tend to see declines in the Nasdaq. However, under positive economic and market conditions, the Nasdaq tends to realize gains.
5. As a Measure of Historical Performance
The Nasdaq composite may be the youngest of the big three indexes, but that doesn’t mean it’s missing out on a strong history. Since 1971, the Nasdaq has been a data-production machine. Today, investors use that data — confident in the idea that history repeats itself — to expand their earnings in the stock market.
Criticism of the Nasdaq Composite Index
While the Nasdaq composite index is one of the most widely recognized U.S. stock market indexes in the world, it is not without its fair share of critics. Some of the most viable criticisms of the Nasdaq include:
- Penny Stocks. Nasdaq Listing Standards make it possible for companies with market caps of $160 million to qualify for listing on the index. In fact, there are several stocks listed on the Nasdaq that have market caps in the penny-stock range. Some experts argue that this exposure to penny stocks, which the Securities and Exchange Commission (SEC) defines as low-priced, speculative securities of extremely small companies, makes investments in the index a risky move.
- Heavy Technology Weighting. Because the index is so heavily weighted toward tech assets, many argue that investing in it leads to overexposure to this space.
- Too Many Assets to Track. The index is one of the largest in existence today, with more than 2,500 assets listed. Some argue that there is no reason for this kind of diversification. In fact, having this many assets to assess makes truly understanding an investment in the index impossible.
While even the most prominent of figures get criticized, they don’t become prominent without being noteworthy. The Nasdaq composite index has earned its position as one of the top indexes, not just in the United States, but in the world.
Although no single investment is a great fit for everyone, investors interested in the technology sector can realize quite a bit of value from the index, even if they don’t invest in it, by using it as an indicator and a yardstick against which to measure performance.
Nonetheless, any time you invest, it’s important to keep in mind that there will be risk. The Nasdaq does best in strong economic times, when innovation in technology is high, and it may realize declines under any other conditions. So, as always, do your research and be cautious when making investment decisions.