From the get-go, the news that Broadcom would be going into the S&P 500 had a powerful effect.
On June 19, the day that
Standard & Poor's
announced the addition, shares of the communications chipmaker tacked on more than 10% as traders plowed into the stock on the expectation that they could sell at a higher price to index funds, which would need to buy Broadcom regardless of cost. And they were right.
Between June 19 and last Friday -- the day it got added to the S&P -- Broadcom shares put on a parabolic move, tacking on 48.4%. And the action was heavy to the very end -- in the last half hour of trading Friday, the stock jumped from 202 21/32 to 218 15/16 -- an 8% move that boosted Broadcom's market capitalization to $47.11 billion from $43.6 billion. Put another way, Broadcom was worth another half-billion dollars -- more than the entire capitalization of
-- every five minutes from 3:30 p.m. to the close.
Bethlehem Steel, as it turns out, is also in the S&P 500. It is the index's weakest member, and there are more than 2,000 non-S&P 500 companies with higher market capitalizations. You wonder why it's in the index at all. You also wonder why Broadcom wasn't put in sooner. It had a market cap around $32 billion when Standard & Poor's made the addition announcement, enough to put it among the top 100 stocks in the index.
The short answer is that the S&P 500 is a qualitative index, not a quantitative one. In order to avoid rapid turnover, Standard & Poor's considers a company's financial and operating conditions before putting it in. As a result, companies like Broadcom, which has a price-to-earnings ratio of 466, take a while to get included.
"Among the criteria is that a company is financially viable," says David Blitzer, a managing director at
Standard & Poor's
and the chairman of the index selection committee. "We have a strong preference for companies that have earnings. A year ago, I got several calls a month asking why we didn't have
in the index. I'm not upset we didn't add that one."
The S&P Effect Rides Again
But Broadcom's market cap has long been in S&P 500 range. Same with
, which wasn't added until this past December. Same with
, which wasn't added until after the close Wednesday, taking over the spot that had been cleared by
, the company
Qwest's fast-approaching addition to the index led to some wild trading in the stock Wednesday afternoon. The shares traded in a tight range around 53 1/2 until 3:30 p.m., when they suddenly spiked as high as 59. Qwest ended late composite trading up 5 3/16, or 10%, to 56 15/16 on a huge 95.2 million shares.
"The reality is that low index turnover comes at a cost," says Diane Garnick, equity derivative strategist at
. Companies like
get held back in the mid-cap
index, while companies like Bethlehem Steel have been members of the S&P 500 forever."
And once a highly capitalized company comes into the S&P 500, it is incredibly disruptive. Once a stock is in the index, it is a purely quantitative game. The higher the market capitalization, the higher the weighting. As a result, when something like Yahoo! or Broadcom comes in, index managers need to buy a ton of stock. This creates tremendous demand, which feeds on itself. Traders can quite rationally run a stock higher, because they know that as it goes up, so will its capitalization, its rank in the S&P 500, and the amount of stock indexers must buy.
By waiting so long to add big stocks to the index, Standard & Poor's has inadvertently created a trading game where, seemingly, there is very little downside.