Nasdaq committed an error and now has to pay the price. The penalty? Having to publicly announce a dramatic “rebalancing” of its noteworthy Nasdaq-100 (QQQ) stock index.
No, there is no admission of guilt. In fact, after the rebalancing, the same flaws will still be in place. Ironically, all this is taking place in index-land – a place where fractions of a decimal number are viewed as important information.
The Nasdaq-100’s “unique” weighting scheme
Most stock indexes (excluding the Dow Jones Industrial Average) weight each security by market capitalization. But not the Nasdaq-100. Starting with market capitalization in 1998 (its prior “rebalancing”), a complex and erroneous set of “adjustments” over the past 12 years has led to company weights that are far from reality.
Different factors produce the changes, but the key culprit is stock performance. Better = more weighting; worse = less. Apple (AAPL) and Microsoft (MSFT) are the companies most out of alignment representative of their radically different returns: AAPL = +3,735%; MSFT = (29)%.
Examples of Nasdaq-100’s flawed weightings
The Nasdaq system now has Apple’s outstanding shares up to 2.4 billion shares - 2.6 times the company’s actual 0.9 billion. Meanwhile, Nasdaq-100 has Microsoft’s shares at only 5.4 billion, two-thirds of the actual 8.4 billon.Based on current prices, Nasdaq-100 has Apple’s valuation at $820 billion, almost six times Microsoft’s valuation of $140 billion. The actual numbers: $310 billion for Apple, about 1.4 times Microsoft’s $220 billion.
So… As investors, we can be annoyed at Nasdaq’s poor weighting scheme. More important, though, we can then think about how to take advantage of the upcoming rebalancing.
Disclosure: I am long AAPL.
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