The Index Game

When S&P added Yahoo to its 500 list, the stock soared. Want to guess what will be next?

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More powerful than Microsoft! Able to leap Time Warner in a single bound! Why, it's Yahoo! In one breathtaking trading session, Yahoo went from being a glitzy dotcom to being one of the largest corporations in the world, surpassing hundreds in market value. And what had Yahoo done to earn the additional $40 billion in market cap? Zip-o. Amazingly, the updraft was a bizarre offshoot of the company's admission, after the close last Tuesday, to the elite Standard & Poor's 500.

As I watched its astounding ascent from $212, when the S&P announced its newest pick, to $348 at the bell, I came to the somewhat sad conclusion--at least for a trader who thrives on identifying diamonds while they are still in the rough--that trying to game the S&P may be the single biggest way to make money in this wacky market.

More than 20 million shares of Yahoo had to be purchased by the funds that run billions of dollars mimicking the S&P 500. This incredibly popular method of indexing creates instant value overnight in a way that a takeover or a restructuring or an earnings surprise can never produce.

The folks at McGraw-Hill, who keep the averages, are a secretive bunch. They didn't explain why Laidlaw, an obscure Canadian company, got the ax and Yahoo got in. But one thing is certain. If this index is going to maintain its integrity as a diversified assemblage of our industrial might, there are more Yahoos ahead. They might not all have the same pop as Yahoo, in part because much of Yahoo is closely held. But because of the newness of some of the candidates and how much is owned--and not traded--by venture capitalists, the pickings here could be huge.

Right now there are more large-cap companies outside the index than at any other time in history, because of investors' massive reweighting toward technology companies. Among those we consider potential admittees are JDS Uniphase, a $42 billion fiber optics company; online retailing colossus Amazon, with $36 billion in market cap; and Veritas Software, no Microsoft but certainly no slouch, with $28 billion in stock-market value. We wonder whether CMGI ($23 billion) or Internet Capital Group ($28 billion) can be kept out for long. Or how about Broadcom, or just created Red Hat, Sycamore, Juniper and Akamai, all with valuations north of $15 billion in their rookie year of trading. You have to believe that these companies would follow a Yahoo-like trajectory because of their thin floats.

Who might get the gate when these newbies claim S&P seats? Such well-known but decidedly no-tech companies as shoemaker Reebok; Russell, the apparel company; and car-part king Pep Boys.

But remember, if you decide to play, that we rarely know when the announcements will be made--these are closely guarded knightings--and the move, while swift on the upside, can be just as death-defying the day after admission. Yahoo, which traded millions upon millions of shares at $348 at the moment of admission at 4:01, sank rapidly to $311 the next day before stabilizing and ending the week at $353.30.

Typically, this kind of rapid-fire turnover is unrewarding because of transaction costs and taxes. But sometimes it is worth sharing a 130-point one-week gain with the broker and the taxman.

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