Basis Points: A View From the Hills

Welcome to the Club

December 2015

Welcome to the Club

by admin on December 15, 2015

Bobby Jones and Cliff Roberts joined together in the 1930’s to turn a plot of land in Augusta, Georgia into the premier golf destination in the United States. Beginning in 1934, the course played host to The Master’s Tournament, which is now considered to be one of the four major championships of professional golf and the only major held on the same course year after year.

Augusta National Golf Club has approximately 300 members, no application process, and inclusion is by invitation only. This select membership failed to include any African Americans until 1990 and didn’t include women until 2012. A quick perusal of the membership list illustrates what is needed to become a member, wealth and power.

Augusta’s facilities aside from the majestic golf course are nothing to write home about and the social scene looks to begin and end on the course. Many of its members rarely even play golf, let alone make the trip to Augusta to do so. The allure of Augusta, no matter how scandalous it’s practices, is the exclusivity.

The First Investment Club

Standard and Poor’s set aside to create their own club. An investment club made up of the most powerful companies the U.S. had to offer. The S&P 500 index came into current form in March 1957. Standard and Poor’s was hopeful that the index would serve as a better way to track the entire U.S. stock market as opposed to the industrial complex that the Dow Jones average tracked.

Initial results were more poor than standard. The index was difficult to price on a daily basis and it was even more difficult to move people away from the DJIA standard. In 1962, Ultronic Systems Corp. signed an agreement with S&P to compute the value of the index along with the other offshoots of the index fathered by S&P. After a rocky start, the technology issues were mostly solved, leaving remaining public perception as the sole road block.

As mutual fund companies created index funds to track the S&P 500, the idea of using the S&P as a benchmark began to take hold. Current technology enables the index to be recalculated every 15 seconds, which has allowed for more participation in index tracking by exchange traded funds (ETF’s).

Current Composition

The Index currently houses 505 stocks that track the performance of 500 companies as some companies have multiple share classes (Alphabet/Google is the most recent example). The index itself is self-policing as membership is attached to a company’s market capital. Companies enter and exit the index at a faster pace than you might expect.

In most years, 25-30 stocks making up the index are replaced. Companies leave the S&P 500 either because poor performance causes their market cap to fall below the threshold, or due to a merger or other recapitalization.

Market-Charts-Of-The-Day

Several high profile financial companies exited the index in 2008/2009 led by FNMA and Freddie and a host of others. When Dell Computer was taken private, it disappeared from the index in 2013. In some rare cases, a spin off can turn one company into two. Ebay’s recent spinoff of Paypal created two separately traded stocks that were both large enough for inclusion.

The addition of a new member, requires the expulsion of an existing member and vice versa. The chart below shows the activity over the last several months. Inclusion in the index is a big deal for a company. Index funds are forced to buy a new member and sell the company it is replacing.

This forced buying and selling can exacerbate moves in the stock price of the company. A cottage industry of index speculators has arisen to try to take advantage. They purchase stocks of companies poised to enter the index. Current favorites of these firms are Tesla and LinkedIn.

  Added Removed  
Date Ticker Security Ticker Security Reason
October 7, 2015 VRSK Verisk Analytics JOY Joy Global Market capitalization change.
September 2, 2015 UAL United Continental Holdings HSP Hospira Inc Hospira taken over
August 28, 2015 ATVI Activision Blizzard PLL Pall Corp Pall taken over
July 29, 2015 SIG Signet Jewelers DTV DirectTV DirectTV acquired by AT&T
July 20, 2015 PYPL PayPal NE Noble Corp PayPal Spun off by eBay
July 8, 2015 AAP Advanced Auto Parts FDO Family Dollar Stores Inc. Family Dollar Aquired.
July 2, 2015 CPGX Columbia Pipeline Group Inc. ATI Allegheny Technologies Spin off of Columbia Pipeline.
July 1, 2015 JBHT J.B. Hunt TEG Integrys Energy Group Inc. Integris taken over.
July 1, 2015 BXLT Baxalta QEP QEP Resources Baxalta spun off by Baxter.
July 11, 2015 QRVO Qorvo LO Lorillard Inc. Lorillard Inc. gets acquired.
April 7, 2015 O Realty Income Corporation WIN Windstream Holdings Inc Market capitalization change.

Instant Inclusion Permanent Exclusion

In some rare cases, a company enters the stock market and the index with little delay. Facebook entered the index less than two years after going public. The same is true for Google. Not every big IPO will be offered the S&P 500 invitation. Alibaba does not meet the current criteria for inclusion, which include 50% public float of shares, and a U.S. domicile.

It is a common misperception that the S&P 500 contains the largest 500 companies listed on the stock market. It does not. The index also doesn’t have to include the largest company outside the index to replace a stock leaving the S&P. Actual inclusion in the index is chosen by a committee. A stock has to meet certain requirements for inclusion but after that the committee is free to pass over a company if it feels the inclusion of an alternative company will help the index better reflect the U.S. Equity Markets.

Much like Augusta National. The S&P 500 has its quirks, and is not as simple or as transparent as we would like, but for the most part the S&P 500 index does a good job of capturing the markets mood and rewarding the ultra-successful companies with membership in a very exclusive club. More importantly, unlike Augusta, the S&P 500 has paved the way for a more diverse group of investors (smaller) to participate in the markets.

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Bobby Jones and Cliff Roberts joined together in the 1930’s to turn a plot of land in Augusta, Georgia into the premier golf destination in the United States. Beginning in 1934, the course played host to The Master’s Tournament, which is now considered to be one of the four major championships of professional golf and…

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