Facebook's Nasdaq 100 Inclusion To Reduce Volatility

Dec.11.12 | About: Facebook (FB)

In a matter of a few months, Facebook (NASDAQ:FB) has gone from a bumbling internet behemoth to a tech darling. Now prior to market open on Wednesday, the tech giant will be added to the NASDAQ-100 Index according to the news release by NASDAQ OMX Group (NASDAQ:NDAQ). An event easily predicted, but another example that has added to the momentum for the stock.

The stock has jumped 50% since mid-November when it traded around $19. At the current price of nearly $28, the company trades at extreme valuations that could finally help the short thesis.

As a firm hoping to short Facebook stock (see articles here), the NASDAQ-100 event could be a signal of a top. Plenty of funds will be forced to buy the stock, hopefully pushing it to near-term highs.

An important question is whether being adding to the index signaled past tops? Similar to how the stock lockup that created potential added sales actually produced the November bottom and the ensuing rally.

NASDAQ 100

The index includes 100 of the largest domestic and international non-financial securities listed on the Nasdaq Stock Market based on market capitalization. The index is calculated under a modified capitalization-weighted methodology.

The index has numerous eligibility requirements for initial and continued inclusion. Some of the more important are as follows:

  • Being listed exclusively on NASDAQ in either the Global Select or Global Market tiers.
  • Being publicly offered on an established American market for three months.
  • Having average daily volume of 200,000 shares.
  • Being current in regards to quarterly and annual reports.
  • Not being in bankruptcy proceedings.

Clearly having a market cap over $50B, it was only a matter of time before Facebook joined this index. The bounce off the November lows could be largely impacted by the expected inclusion in this major index.

Also worth noting and likely overlooked by the market, the announcement by NASDAQ included the stock's addition to the NASDAQ-100 Equal Weighted Index (NDXE) and the NASDAQ-100 Technology Sector Index (NDXT). These indexes are tracked by the following ETFs that will add the corresponding amount of Facebook shares:

NASDAQ-100 Index - PowerShares QQQ Trust ETF (NASDAQ:QQQ)

NASDAQ-100 Equal Weighted Index - First Trust NASDAQ-100 Equal Weighted Index Fund (NASDAQ:QQEW)

NASDAQ-100-Technology Sector - First Trust NASDAQ-100 Tech Index ETF (NASDAQ:QTEC)

Recent NASDAQ-100 Index Updates

The recent results are very mixed on whether the inclusion or exclusion from the list causes stock moves. Per Wikepedia the following index updates have been made this year:

  • On April 23, 2012, Texas Instruments (NASDAQ:TXN) replaced First Solar (NASDAQ:FSLR) prior to the market open.
  • On May 30, 2012, Viacom (NASDAQ:VIAB) became a component of the index prior to the market open. It replaced Teva Pharmaceutical Industries (NYSE:TEVA), which transferred to the NYSE.
  • On July 23, 2012, Kraft Foods, Inc., now known as Mondelez International (NASDAQ:MDLZ), became a component of the index prior to the market open, replacing Ctrip (NASDAQ:CTRP).

Looking at these three scenarios, only two involved forced replacements of stocks. In both scenarios, the removed stock performed much better from that date. See the charts below:

TXN Total Return Price Chart

TXN Total Return Price data by YCharts

CTRP Total Return Price Chart

CTRP Total Return Price data by YCharts

* The chart doesn't show the Mondelez return for the first two months due to the split, but the end results are ironically similar to the one presented.

Maybe a better indication of the impact on Facebook was the dramatic shakeup in the index about a year ago. On December 19, 2011, five companies joined the NASDAQ-100 index prior to the market open as a result of NASDAQ's annual reranking of the index. The additions were Avago Technologies (NASDAQ:AVGO), Fossil, Inc. (NASDAQ:FOSL), Monster Beverage (NASDAQ:MNST), Nuance Communications (NASDAQ:NUAN), and Randgold Resources (NASDAQ:GOLD). These companies replaced FLIR Systems (NASDAQ:FLIR), Illumina (NASDAQ:ILMN), NII Holdings (NASDAQ:NIHD), Qiagen (NASDAQ:QGEN), and Urban Outfitters (NASDAQ:URBN).

As the charts below show, the stocks added to the index had poor performances on a relative basis and were much less volatile. The companies removed from the index had more dramatic moves, though ironically three had very positive performances. In fact, the removed stocks in total performed better. See charts below:

AVGO Total Return Price Chart

AVGO Total Return Price data by YCharts

FLIR Total Return Price Chart

FLIR Total Return Price data by YCharts

Instagram Blocks Twitter

In an unsurprising move, Instagram blocked the direct feed of their filtered pictures on Twitter by no longer supporting Twitter cards. The move was made to force Twitter users back to the Instagram website. The irony is that Facebook, which now owns Instagram, continues to highlight to businesses that any business plan based on Facebook as a network is bound to failure.

Interestingly, Twitter apparently plans to offer a similar competing photo-sharing product. Do users want to constantly update multiple networks? My guess is that a lot of users will directly adopt the Twitter version and bypass Instagram.

While unrelated to the index inclusion, this war with Twitter could shape the direction of the stock greatly over the next 6 months.

Conclusion

Nothing fundamentally has changed from the original conclusions that the stock is overvalued. Based on the momentum, the theory was that the stock could easily run to $32 over the next month before the excitement ends. At the time, the thought was that the stock needed a catalyst in order to turn the momentum back negative. The inclusion in the NASDAQ-100 could create that catalyst though recent history doesn't suggest enough volatility for a good short.

Unfortunately, the recent data actually suggests that Facebook will become a dull stock now that it has joined this major index. The stock will continue to be monitored for the ideal time to short, but this major event doesn't appear to create a catalyst for a major top.

Disclosure: I am long NIHD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Please consult your financial advisor before making any investment decisions.