S&P Dow Jones Indices is changing how it decides which U.S. stocks count as growth and which count as value. That change will affect billions of dollars in index-tracking money, forcing a reshuffle before year's end.
After a consultation with market participants, the index provider will add free cash flow, forward earnings, and intangible assets to its value screens. It will also drop 12-month price momentum from its growth ranking. The overhaul takes effect at the annual reconstitution before the market opens on Dec. 21.
Big and Small Changes
Growth gets the smaller change. S&P will now rank growth on just two measures: the three-year net change in earnings per share relative to price, and three-year sales-per-share growth. Momentum, which tends to reward stocks that have already rallied, is out.
Value gets the bigger rebuild. An intangibles-adjusted version replaces the traditional book-to-price ratio. Trailing earnings-to-price will be averaged with forward one-year earnings-to-price. Sales-to-price stays, and free cash flow-to-price joins as a fourth factor.
However, the cash-flow measure won't apply to real estate, banks, insurers, mortgage REITs, and certain financial firms. Those companies will be scored on the remaining factors.
The Long-Standing Debate
These changes build on a long-running debate over whether classic value measures still identify cheap stocks. The persistent criticism is that value's long slump partly reflects flawed metrics, especially price-to-book.
Accounting rules usually treat research spending and internally built know-how as an expense rather than a balance-sheet asset. Yet this approach makes companies with substantial intellectual property expensive on paper and keeps them out of value indexes.
The new rules apply to all S&P U.S. Style Indices, including the Pure Style versions. That list covers growth and value gauges for the S&P 500, MidCap 400, SmallCap 600, Composite 1500, S&P 1000 and S&P 900, plus the sub-indexes and custom indexes built on them.
The ETF Angle
According to Bloomberg Intelligence analyst James Seyffart, at least $375 billion in passive funds track the affected gauges. Most of it sits in large caps.
The iShares S&P 500 Growth ETF (IVW) holds about $77 billion in assets, the SPDR Portfolio S&P 500 Growth ETF (SPYG) roughly $57 billion, and the iShares S&P 500 Value ETF (IVE) about $50 billion. Together, the three hold around $184 billion, nearly half of Seyffart's estimate.
As stocks move between style buckets, these funds will have to sell the names that leave and buy the ones that join, so trading will bunch up around the rebalance date.
Furthermore, S&P isn't alone. FTSE Russell is reconsidering the 50/50 growth-value split in its benchmarks because tech giants dominate the market. That consultation should close on Dec. 11.
Clients will first see the changes in pro forma files starting Friday, Dec. 4. That gives traders about two weeks to position before the revised indexes go live ahead of the open on Monday, Dec. 21.
