Reconstructing the Russell Indexes
If you own a stock with market capitalization of around $215 to $250 million dollars, watch your stock closely over the next week. You may be in for a surprise, especially on Monday, June 15.
Why? The Russell 3000r and Russell 2000r indexes are being rebalanced as we speak. The Russell Indexes are determined by market data as of the close on May 31, each year. For the next two weeks, the firm runs it proprietary calculations (basically market capitalization with some adjustments).
After the market close on Friday, June 12, the preliminary list of the new components of the index will be published. Any stock which gets dropped from the index is likely to have a short-term sharp drop in value. Any stock which gets added is likely to have a short-term pop in price. The list is finalized on July 1.
The Russell Indexes
The Russell Indexes measure nearly all of the US equity markets, by market capitalization. The Frank Russell company, which builds and maintains the indexes, does make some adjustments to straight market capitalization numbers, such as not including companies whose shares trade for less than $1.00, and adjusting for shares not available for trading (stock option shares and large private individual or corporate held shares for example), if such shares constitute more than 10% of the outstanding shares.
The Russell 3000 Index comprises the top 3000 companies in the market. This accounts for 98% of the total market capitalization of all US markets. The Russell 1000 index comprises the top 1000 companies in the Russell 3000. The Russell 2000 comprises the next 2000 companies in the Russel 3000 index.
Why is the Russell reconstruction important? There is approximately $100 billion currently invested in index funds that mimic the Russell indexes. As soon as new components of the Russell indexes are published, these funds will start dumping the stocks which are dropped, and buying the stocks which are added.
Each year, hundreds of stocks are added and dropped from the index. Last year, 450 companies were added to the Russell 3000 Index, and 324 were removed. (126 companies were dropped during the year due to mergers or bankruptcies; they are not replaced during the year.)
For most companies in the Russell 3000, the reconstruction has little or no effect on the market price of the stock. The stocks likely to be most affected by the Russell Indexes adjustments are those at the bottom of the list, which are dropped. Stocks which move from the Russell 2000 to the Russell 1000 generally don't see the same kind of market adjustment as they move from one index fund to another.
Because the Russell indexes are calculated with a somewhat complicated set of rules, it is hard to fudge your own Russell "pre-calculations" to figure out what stocks are likely to make the new index.
However, we offer the following criteria to consider whether your investment will be affected by the Russell Index reconstruction. The stocks most likely to be affected are those at the bottom of the Russell 2000 index.
First , determine if your stock is part of the current Russell 2000 Index (If it had a market capitalization of higher than $171 million last year, it probably is. ) Check this list: russell.com. This will give you a page with links to display the Russell 3000, 1000, or 2000 index stocks, alphabetically. (Displaying the list requires Adobe Acrobat).
Next, look up your stock's current market capitalization. Last year the smallest company on the list (the 3000th company) was Santa Cruz Operation, at $171.7 million in market capitalization. We expect this year's cut-off to be around $225 million, if not higher.
If your stock WAS NOT in the Russell 2000 last year, and the current market capitalization is between $220 and $270 million or higher, and the stock price is larger than $1.00, your stock stands a good chance to be added to the index.
If your stock WAS in the Russell 2000 last year, and the current market capitalization is below $220 million, be wary. There is a strong possibility that your stock may be dropped from the Russell 2000 index. If the stock price was less than $1.00 per share on May 31, the stock will be dropped.
What to do if your stock is dropped from the index? Quite likely the stock has been an underperformer this year (that's why it falls off the list), and you may want to take a long look at your holdings. But, if you still believe in the future of the company, ignore the short-term drop in price. If you do decide to sell, remember that you are selling at the same time as the index funds.
Can you play the possibility of a stock being added to the index? You can, but bear in mind that the index funds have been running calculations for weeks prior to the Russell announcements, in attempts to identify the likely candidates. Market arbitragers have already been at work trying to identify the likely additions and rejections. Although there will likely be some room to profit from Thursday or Friday's price and Monday's post-announcement price, it is beyond the abilities of most investors to duplicate the Russell calculations.
But if you really want to look for a likely addition, here are some of the things to look for:
Current Market Capitalization higher than $250 million (market capitalization is price on May 31 times outstanding shares, but not including preferred, convertible, or redeemable shares, or warrants.)
Privately held or cross-corporate held shares are either less than 10%, or if greater than 10%, the market capitalization is still greater than $225 million when the privately held shares are subtracted
Current price greater than $1.00 (on May 31)
New IPO in the last year (this is how many additions make the list)
Not a bulletin board or pink-sheet stock
Headquarters in the US
If you find a stock that meets these characteristics, and want to take a flyer on it being added to the Russell 3000 Index, good luck. But bear in mind that others are looking too, and by the time July comes, it is just another stock, along with the 2999 others in the Russell universe.
Russell 3000, Russell 2000 and Russell 1000 are registered trademarks of the Frank Russell Company.
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from Briefing.com
6-10-98
briefing.com |
