It’s not often that the curators of a closely watched stock index have to publicly confess that the index has grown so inaccurate it needs to be fixed. It’s even rarer when the fix results in the index becoming less relevant.
That’s what happened Tuesday when Nasdaq OMX (NASDAQ:NDAQ), the publicly traded company that owns the Nasdaq stock market, declared it would undertake the first “special rebalancing” in 13 years of the Nasdaq 100 index. Such rebalances are triggered when a company comes close to taking up 24% of the index’s market cap.
In this case, that means a little stock called Apple (NASDAQ:AAPL). After the rebalance, Apple’s weight in the Nasdaq 100 will drop to 12.3% from its current 20.5%. Microsoft’s (NASDAQ:MSFT) weight will rise to 8.32% from its current 3.41%.
That is kind of ironic, because the last time the index was rebalanced, in December 1998, Microsoft was the stock that had thrown the index out of whack. Between the Nasdaq 100’s creation in January 1985 and the 1998 rebalancing, it had risen more than 30,000%.
Partly because that rebalance came just as Apple was beginning one of the greatest second acts in corporate history, its stock was greatly undervalued. As a result, Apple’s stock has risen 4,000% since that 1998 rebalance.
Nasdaq says the new rebalance will cause the index to better reflect the actual weightings these stocks will have in the Nasdaq 100. And in some ways, the index will become an even truer proxy for the technology index than it was before. This is because tech stocks will now make up 61.9% of the Nasdaq 100, compared with the 59.5% ratio before the rebalance.
Unfortunately, all of this overlooks a critical point. People look at the Nasdaq 100 not just as a tech index, but as a proxy for marquee-name growth stocks. Over the past five or 10 years, the tech industry has stopped being a haven for growth stocks.
Unlike the 1990s, which was the last period that saw a sustained tech rally, the tech sector has really become two industries. One is made up of pioneers like Microsoft, Dell (NASDAQ:DELL) and Cisco (NASDAQ:CSCO) that are doing a bad job of keeping up with a sector where growth is coming from the “cloud,” the Web and mobile technologies.
These stocks aren’t exactly the ones setting the tech agenda in the coming decade. Their price-to-forward-earnings ratios are below 10. Their net profits are flat or growing in the single digits. And some of them, like Microsoft, have resorted to enticing investors with dividends — the badge of the over-the-hill company. These aren’t growth stocks anymore, they are value stocks.
The companies in the second technology industry are brands like Apple, Netflix (NASDAQ:NFLX), Google (NASDAQ:GOOG). They are doing a decent job of innovating in these areas — or at least keeping their heads above water. When people talk about innovation in Silicon Valley and the profit growth they bring, they mean companies like these. In particular, they mean Apple.
Much of the coverage of the Nasdaq 100 rebalance centered on the news that index funds tracking the Nasdaq 100 will be forced to sell shares in overweighted stocks like Apple and buy underweighted ones like Microsoft. But so far the impact has been limited. Apple closed Tuesday down 0.7%, and Microsoft closed up 0.9%.
Over time, the real impact of the rebalance might hit those Nasdaq 100 funds themselves. The index is no longer a proxy for tech growth stocks. It’s not even a proxy for tech value stocks. It’s just a collection of 100 larger-cap, mostly tech companies that happen to be listed on the Nasdaq instead of the NYSE or Amex.
If for some reason that’s what you need in your investment portfolio, then this is the index for you. But for investors who want a piece of the future success in Silicon Valley — the explosive growth in mobile technology, the social web and cloud computing — there are much better opportunities around.
They might start by considering a stock called Apple.