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March 27, 2006

Google Gets Added to S&P 500: Post Addition Performance is Disappointing

posted by MR WAVETHEORY at 3/27/2006 01:21:00 AM

The WSJ writes that many trading desks overestimated the number of Google shares index funds were required to buy because the S&P is float weighted rather than market cap weighted. Instead of being required to buy 28 million shares as most of the Street had expected, index funds were only required to buy 18.8 million shares. That means most buyers of Google overestimated the potential demand by 48%. No wonder the stock opened at $368.62 and closed at $365.80. Frankly, the performance was underwhelming.

The S&P 500 is a "float weighted" index. That means a company's prominence in the index is determined by the value of shares available to the public. In the case of Google, a big chunk of shares aren't publicly available. Instead, they are held as a separate class by founders Larry Page and Sergey Brin as well as other insiders.

The information S&P first provided on Google last week left many Wall Streeters thinking the company would go into the S&P 500 index as if all its shares -- including the ones held by insiders -- were freely floating. But the announcement was misinterpreted, says S&P managing director David Blitzer. Insider shares aren't counted.

Instead of needing to buy about 28 million shares, index funds will need 18.8 million, according to Credit Suisse's derivative strategy group. When S&P corrected the misimpression, a flurry of selling resulted. In 15 minutes on Friday, the share price fell to $363.70 from $368, a 1.2% decrease.

For the record, Google traded 15.1 million shares on Friday which means if index funds all started to buy on Friday (rather than earlier), then there are 3.7 million additional shares to be bought. This is a far cry from most estimates that there will be multiple days of supply imbalances. I seriously doubt index funds would have waited until Friday to buy.

Did A Few Large Hedge Funds Trade on Inside Information Prior to Google's Addition into the S&P 500?

Some bloggers have pointed out that some funds may have had advance information on the S&P addition. Large numbers of deep in the money puts were apparently sold prior to the close on Thursday. On Friday, they would have been worth substantially less, netting the put sellers a substantial profit. While I don't have the figures on hand, I have seen figures estimating that the value of the puts sold is anywhere between $50 to $100 million worth of contracts.

Google's Valuation Is Guilty Until Proven Innocent

Frankly, I find it unforgivable that most investors still haven't realized that Internet stocks go from undervalued to overvalued and are never fairly valued. When Google completed its IPO, it was undervalued and the valuation was "innocent until proven guilty." Today, Google is overvalued especially after the latest earnings miss and the valuation is "guilty until proven innocent."

Mr Wave Theory

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