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Indexing nerds and short-term traders, among other market participants, pay close attention to S&P 500 inclusion process, which in theory should be relatively straight-forward.
After all, it’s a cap-weighted index, implying that when S&P Dow Jones Indices rebalances the gauge or companies depart due to allocation, the “next man up” that meets market capitalization and profitability criteria will be added. Those mandates include having a minimum market value of $22.7 billion and demonstrated profitability over recent quarters/the trailing 12 months. Other requirements are a stock having its primary listing on one of the major domestic exchanges and the company in question maintaining a U.S. headquarters.
Undoubtedly, S&P 500 inclusion is a big deal as it acts as a near-term catalysts for the added stocks because fund issuers and active managers tracking the index have to buy the newly added equities while selling the departing names. Consider this fact: the three largest ETFs each track the cap-weighted version of the S&P 500 and that trio combines for more than $2 trillion in assets under management.
That is to say investor’ enthusiasm for tracking S&P 500 inclusions is understandable as is their perplexed state following the index provider’s recent decisions.
Recent S&P 500 Additions Are Head Scratchers
The most recently announced joiners to the S&P 500 are The Trade Desk (TTD), Datadog (DDOG) and Block (XYZ). Indeed, each of those stocks meets the parameters for being part of the S&P 500. As of Monday, July 28, Datadog’s market cap was just under $52 billion while Block and The Trade Desk checked in at $49.29 billion and $42.21 billion, respectively.
Here’s why investors in still excluded names such as AppLovin (APP), Robinhood Markets (HOOD) and, to a lesser extent, Flutter Entertainment (FLUT) are right to be vexed. By market cap, FanDuel owner Flutter is the smallest member of that trio and its market cap as of July 28 was $53.72 billion. So what gives?
“Instead, the S&P 500 is designed to represent the entire market, meaning the weight of various sectors plays a part. If decision-makers at S&P Dow Jones think the S&P 500 has enough weighting in technology but not enough in consumer discretionary, it may select DoorDash and not AppLovin,” according to Charles Schwab research.
That line of thought is valid, but it doesn’t track with S&P recent decisions. Tech is already far and away the S&P 500’s largest sector weight and the three most recent additions all hail from that sector. For its part, Block is replacing Hess – an energy stock.
Translation: S&P Dow Jones Indices added three tech stocks to an index that’s already heavily allocated to that sector, perhaps too much so, when three alternatives – AppLovin, Flutter and Robinhood – aren’t tech stocks and each have bigger market caps than the freshly added names. Again, make it make sense, S&P.
To Be Fair…
In fairness to S&P, market cap isn’t the sole requirement for S&P 500 inclusion.
“One possible reason, though S&P Dow Jones Indices doesn't specifically explain its quarterly decisions, could be the index's composition. The people who put the S&P 500 together don't base it simply on the top-500 market capitalizations,” adds Schwab.
Additionally, the index provider isn’t attempting to avoid large weights to some sectors and small exposure to others. Rather, it’s endeavoring to build a gauge that’s representative of the U.S. equity market and economy.
Still, a little more clarity on the process would likely be appreciated by investors of all stripes. AppLovin and Robinhood shareholders would certainly like to know when their beloved stocks will get the coveted S&P 500 promotion.
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