Time to include new stocks in index?

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RadAudit
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Time to include new stocks in index?

Post by RadAudit » Fri May 10, 2019 9:25 pm

How long does it take before a new stock (IPO like Uber) is incorporated in to a Total Stock Market fund?
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Re: Time to include new stocks in index?

Post by LadyGeek » Fri May 10, 2019 10:00 pm

That's a great question. The Friday night Nightly Business Report actually ran a story on that. The short answer is that Uber does not qualify to be added to an index fund any time soon. Why? It's running at a loss.

Knowing the answer, I did some research. From the wiki: Stock market indexing

In order for a stock to be included in an index, it must meet very strict criteria. Every index has a methodology which defines exactly what's needed.

The S&P 500 index methodology can be found here: S&P 500® - S&P Dow Jones Indices

Methodology (drop-down list) --> S&P US Indices Methodology (describes all US indexes created by S&P Dow Jones, Inc.)

From page 7 (page 8 in the PDF):
S&P Composite 1500. The sum of the most recent four consecutive quarters’ Generally Accepted Accounting Principles (GAAP) earnings (net income excluding discontinued operations) should be positive as should the most recent quarter.
The above is only stated for the S&P Composite 1500, but the reporter mentioned that no index will accept Uber until they've shown a track record of 4 consecutive quarters at a profit.

As it stands now, Uber (and Lyft) are a long way away from meeting this requirement.
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Re: Time to include new stocks in index?

Post by LadyGeek » Fri May 10, 2019 10:16 pm

The Vanguard Total Stock Market ETF (VTI) tracks the CRSP US Total Market Index, which is created by a different company and has different criteria.*

See: CRSP U.S. Equity Indexes Methodology Guide

The Equity-Indexes-Methodology-Guide has different criteria. I don't see anything related to maintaining profitability over 4 consecutive quarters.

I do see mention that 20 days trading or greater is required for new securities. I'm not sure how Uber would qualify for this index and will defer to the experts on this one.

* Center for Research in Security Prices (CRSP), part of the University of Chicago’s Booth School of Business. About CRSP
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Re: Time to include new stocks in index?

Post by RickBoglehead » Fri May 10, 2019 10:50 pm

LadyGeek wrote:
Fri May 10, 2019 10:00 pm

As it stands now, Uber (and Lyft) are a long way away from meeting this requirement.
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Re: Time to include new stocks in index?

Post by HawkeyePierce » Fri May 10, 2019 11:58 pm

Fascinating that CRSP specifically calls out Berkshire Hathaway as its own organization type.

I wonder how this works for companies like Slack and Spotify which did direct listings instead of traditional IPOs. CRSP's guide says they're eligible but I wonder how long it takes for enough shares to actually float?

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Re: Time to include new stocks in index?

Post by fujiters » Sat May 11, 2019 1:18 am

Glad I wasn't alone in my concerns that the constantly-operating-at-a-loss Uber would soon show up in my index funds.

Having a consistent positive earnings record is a sensible threshold for inclusion in an index.
“The purpose of the margin of safety is to render the forecast unnecessary.” -Benjamin Graham

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Re: Time to include new stocks in index?

Post by HEDGEFUNDIE » Sat May 11, 2019 1:23 am

fujiters wrote:
Sat May 11, 2019 1:18 am
Glad I wasn't alone in my concerns that the constantly-operating-at-a-loss Uber would soon show up in my index funds.

Having a consistent positive earnings record is a sensible threshold for inclusion in an index.
And yet, the index fund that includes all companies including unprofitable ones (VTI) has outperformed the one with the profitability filter (ITOT).

https://www.portfoliovisualizer.com/fun ... F10%2F2019

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Re: Time to include new stocks in index?

Post by Iridium » Sat May 11, 2019 1:59 am

LadyGeek wrote:
Fri May 10, 2019 10:16 pm
See: CRSP U.S. Equity Indexes Methodology Guide

The Equity-Indexes-Methodology-Guide has different criteria. I don't see anything related to maintaining profitability over 4 consecutive quarters.

I do see mention that 20 days trading or greater is required for new securities. I'm not sure how Uber would qualify for this index and will defer to the experts on this one.
I am not an expert, but per those guides, it looks like Uber will qualify as a fast track IPO. If so, it will be added after 5 days of trading; in other words, next week.

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Re: Time to include new stocks in index?

Post by fujiters » Sat May 11, 2019 2:56 am

HEDGEFUNDIE wrote:
Sat May 11, 2019 1:23 am
fujiters wrote:
Sat May 11, 2019 1:18 am
Glad I wasn't alone in my concerns that the constantly-operating-at-a-loss Uber would soon show up in my index funds.

Having a consistent positive earnings record is a sensible threshold for inclusion in an index.
And yet, the index fund that includes all companies including unprofitable ones (VTI) has outperformed the one with the profitability filter (ITOT).

https://www.portfoliovisualizer.com/fun ... F10%2F2019

Point taken.

Both funds have only been in existence for the past 15 years, but VTI has pretty consistently outperformed.

I have to keep reminding myself that I don't know better than the market. I've also been expecting international to outperform the US market for years... Clearly I don't know nothin.
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RadAudit
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Re: Time to include new stocks in index?

Post by RadAudit » Sat May 11, 2019 9:56 am

LadyGeek wrote:
Fri May 10, 2019 10:00 pm
That's a great question.
Thanks for summarizing and posting the info.
FI is the best revenge. LBYM. Invest the rest. Stay the course. - PS: The cavalry isn't coming, kids. You are on your own.

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Re: Time to include new stocks in index?

Post by jbranx » Sat May 11, 2019 2:39 pm

Looks like LadyGeek linked to all the best resources on index inclusion criteria. There is this additional info from Vanguard in the appendix (pages 13-15): https://institutional.vanguard.com/iam/pdf/ICRPBD.pdf comparing the various indices it uses.

When Vanguard switched some of its index funds from S&P to MSCI before moving later to CRSP, it was the criteria for removal as much as inclusion, with MSCI creating "bands" around the capitalization criteria to reduce turnover, which Vanguard saluted as an indexing advantage. When the 500 was essentially its only index, S&P's quality screen included a review of the stock's S&P Quality Ranking, which required ten years of data on EPS and dividends.

Objections to a "subjective" index committee picking stocks has led all the index providers to publish their "rules" for index governance, but it looks like many of them still have advisory boards or committees of some kind to deal with the complexities that arise, especially in global stocks where the exchange listing criteria and local regulatory rules differ from country to country and "float" is hard to nail down.

One question I have is whether there is implicit view at most of the index providers that a large IPO will eventually be profitable, therefore, getting the stock in early will be the best reflection of market returns? The advent of "profitless IPO's" may be a new era phenomenon that requires some further evaluation of inclusion rules and the effect of negative EPS on index data. With the exception of very narrow indexes like the Dow 30, the market will quickly take care of "rebalancing" the stock to its rightful value in a broad index, and those of us who own VTI and VT will have nothing to be concerned about.

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