Index filter false market cap?

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ChinchillaWhiplash
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Index filter false market cap?

Post by ChinchillaWhiplash » Mon Jun 10, 2019 8:41 am

Do indexes (TSM or S&P 500) filter out stocks that might be artificially inflated in price/valuation? Example would be a stock that has run way up to be heavily shorted. TSLA comes to mind. Or is this something that would happen only in a factor based fund?

Silk McCue
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Re: Index filter false market cap?

Post by Silk McCue » Mon Jun 10, 2019 8:55 am

That would require active management and is the antithesis of an Index fund. They would be sued if they did that.

I can't speak to factor funds.

Cheers

Jags4186
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Re: Index filter false market cap?

Post by Jags4186 » Mon Jun 10, 2019 8:57 am

Yes for the SP500 no for the TSM. Tesla is not in the SP500. It is in the TSM. It is certainly one of the 500 largest American companies.

SP500 is chosen by committee.

marcopolo
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Re: Index filter false market cap?

Post by marcopolo » Mon Jun 10, 2019 9:01 am

Jags4186 wrote:
Mon Jun 10, 2019 8:57 am
Yes for the SP500 no for the TSM. Tesla is not in the SP500. It is in the TSM. It is certainly one of the 500 largest American companies.

SP500 is chosen by committee.
Even theTSM funds do not hold EVERY stock in the market. Someone, or something (algorithm) is doing some filtering.
I doubt either the S&P500, or various TSM, however, use "valuation" or "run up" as a filtering criteria.
Once in a while you get shown the light, in the strangest of places if you look at it right.

MotoTrojan
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Re: Index filter false market cap?

Post by MotoTrojan » Mon Jun 10, 2019 9:11 am

marcopolo wrote:
Mon Jun 10, 2019 9:01 am
Jags4186 wrote:
Mon Jun 10, 2019 8:57 am
Yes for the SP500 no for the TSM. Tesla is not in the SP500. It is in the TSM. It is certainly one of the 500 largest American companies.

SP500 is chosen by committee.
Even theTSM funds do not hold EVERY stock in the market. Someone, or something (algorithm) is doing some filtering.
I doubt either the S&P500, or various TSM, however, use "valuation" or "run up" as a filtering criteria.
OP, the S&P500 does have quality filters that prevent companies with persistent negative earnings from getting into the index. This won't help a stock that is skyrocketing and already in the index, but would help keep a company like Tesla out until they become more appropriately priced (due to making a profit, not plummeting).

This is one of the reasons my preferred small-cap value index is the S&P600, although my 401k only has Vanguard's CRSP-based fund so that is currently my main holding for that asset class.

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Re: Index filter false market cap?

Post by nisiprius » Mon Jun 10, 2019 11:40 am

ChinchillaWhiplash wrote:
Mon Jun 10, 2019 8:41 am
Do indexes (TSM or S&P 500) filter out stocks that might be artificially inflated in price/valuation? Example would be a stock that has run way up to be heavily shorted. TSLA comes to mind. Or is this something that would happen only in a factor based fund?
To avoid TSLA, you don't necessarily need a "factor based fund." It could be excluded by various not-cap-weighted index and index-like funds. It certainly could be excluded by actively managed funds.

For example, Tesla doesn't pay dividends, so it would not be included in dividend-focussed funds, even if they are index funds.

I don't think it's easy to recognize stocks that are "artificially inflated" in price. And any stock might be "artificially inflated" in price. Once people give up on the idea of picking the good stocks, it still sounds plausible to hope that you can at least avoid the obvious dogs. But it's no easier than picking the good ones; that was more or less proven by the disastrous track record of 130/30 funds. Everyone who buys TSLA is someone who thinks it is worth $213/share. If everyone thought it was overpriced, nobody would buy it and the price would drop until it wasn't.

And, of course, if you own the stock, a gain is a gain whether or not it is "artificial." Offhand, if you're going to play stock-picking games, you would like to be holding stocks that are artificially inflated as long as the inflation process is continuing.
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alex_686
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Re: Index filter false market cap?

Post by alex_686 » Mon Jun 10, 2019 12:08 pm

Jags4186 wrote:
Mon Jun 10, 2019 8:57 am
Yes for the SP500 no for the TSM. Tesla is not in the SP500. It is in the TSM. It is certainly one of the 500 largest American companies.

SP500 is chosen by committee.
Why does it matter that the S&P 500 is chosen by committee? TSM is based on CRSP, which is also done by committee. If fact, all indexes are chosen by committee.

Back to the OP, indexes do not filter on "artificially inflated in price/valuation". They do filter on investiblity. Free float, daily volume, etc. There is some subjective here, but I also think it is a bit of a false flag. As a analogy, no referee is perfect, and they all have basis. This does not really matter as long as the biases is small and consistent. It only matters if the referee is favoring one team over another, and I don't think that is coming into play here.

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Re: Index filter false market cap?

Post by Jags4186 » Mon Jun 10, 2019 12:54 pm

alex_686 wrote:
Mon Jun 10, 2019 12:08 pm
Jags4186 wrote:
Mon Jun 10, 2019 8:57 am
Yes for the SP500 no for the TSM. Tesla is not in the SP500. It is in the TSM. It is certainly one of the 500 largest American companies.

SP500 is chosen by committee.
Why does it matter that the S&P 500 is chosen by committee? TSM is based on CRSP, which is also done by committee. If fact, all indexes are chosen by committee.

Back to the OP, indexes do not filter on "artificially inflated in price/valuation". They do filter on investiblity. Free float, daily volume, etc. There is some subjective here, but I also think it is a bit of a false flag. As a analogy, no referee is perfect, and they all have basis. This does not really matter as long as the biases is small and consistent. It only matters if the referee is favoring one team over another, and I don't think that is coming into play here.
I supposed it doesn’t matter if it is chosen by committee. My point is that just being on of the 500 largest companies doesn’t get you into the SP500, as many people would believe. There are specific screens which SP uses to determine if a stock is eligible:

1) market capitalization
2) liquidity
3) domicile
4) public float
5) sector classification
6) financial viability
7) length of time publicly traded
8) stock exchange

There are companies that may or may not be “financially viable”, among other things, in the TSM that are not included in the SP 500. Tesla is one of them.

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Phineas J. Whoopee
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Re: Index filter false market cap?

Post by Phineas J. Whoopee » Mon Jun 10, 2019 1:10 pm

What's a false market cap? Did somebody make an error in the multiplication?

Or does it mean you personally disagree with the share price the most eager buyer and most eager seller most recently traded at? If it's that you're talking about part and parcel of capital markets. They're based on disagreements over proper securities values.

PJW

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nisiprius
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Re: Index filter false market cap?

Post by nisiprius » Mon Jun 10, 2019 1:20 pm

As best I can remember, Standard & Poor's has always described the S&P 500 the same way: an index of the stocks of "leading companies in leading industries." They have never described it by reference strictly to market capitalization. The inception of the S&P 500 was in 1957. Back then, there was very little interest in small-caps. S&P's "leading companies in leading industries" were the market as far as most people were concerned. It only covered 500 stocks because that was the maximum number S&P could calculate on a daily basis.

It wasn't until 1974 that Wilshire began trying to index the entire stock market (the Wilshire 5000).

It wasn't until 1981 that Rolf Banz published a paper that sparked huge interest in, and enthusiasm for small-caps, leading to the current situation in which it seems natural to segment the market by market capitalization, and expect indexes to have cut-offs by capitalization.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

pdavi21
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Re: Index filter false market cap?

Post by pdavi21 » Mon Jun 10, 2019 4:36 pm

The short answer is it doesn't matter.
The SP 500 is about 80-85% of the total US stock market and will behave very similarly over time even with the closeted active management.
"We spend a great deal of time studying history, which, let's face it, is mostly the history of stupidity." -Stephen Hawking

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ChinchillaWhiplash
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Re: Index filter false market cap?

Post by ChinchillaWhiplash » Tue Jun 11, 2019 10:06 am

Was basically wondering if indexes filter out stocks with a high percentage of short interest. There are some stocks out there with real high short interest. I've seen some with over 30%. A lot of these also have high volatility. Seems like a way to filter out those stocks that are going to be unpredictable and could drop like a rock through some form of manipulation by traders.

alex_686
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Re: Index filter false market cap?

Post by alex_686 » Tue Jun 11, 2019 10:28 am

Jags4186 wrote:
Mon Jun 10, 2019 12:54 pm
There are companies that may or may not be “financially viable”, among other things, in the TSM that are not included in the SP 500. Tesla is one of them.
"Financially Viable" means the company has declared bankruptcy, has stooped paying on its debt, can't get the auditor and exchange to sign off on its annual report, etc. That is, the company is melting down - not that it might be melting down.

Tesla's problem is limited liquidity, that a high percentage of stocks are held by insiders, and the lack of rights for minority shareholders.

alex_686
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Re: Index filter false market cap?

Post by alex_686 » Tue Jun 11, 2019 10:30 am

ChinchillaWhiplash wrote:
Tue Jun 11, 2019 10:06 am
Was basically wondering if indexes filter out stocks with a high percentage of short interest. There are some stocks out there with real high short interest. I've seen some with over 30%. A lot of these also have high volatility. Seems like a way to filter out those stocks that are going to be unpredictable and could drop like a rock through some form of manipulation by traders.
No - no index that I know of. And I am not sure that a high percentage of short interest would be a strong signal. There are some stocks that have had a high short interest for long periods of time that have not dropped like a rock, and others with a low short interest that have.

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