Wednesday 26 October 2016

Facebook: the €284bn omission from the Dow Jones Index

Facebook is one of the world's biggest companies, writes Anna-Louise Jackson. So why then isn't it part of the world's biggest stock market index?

Anna-Louise Jackson

Published 10/04/2016 | 02:30

Mark Zuckerberg founded Facebook in 2004 and the company is now worth €284bn
Mark Zuckerberg founded Facebook in 2004 and the company is now worth €284bn

It's the sixth-largest US company, the fastest ever to reach $250bn in value, with revenue that has quintupled in four years. And yet Facebook Inc isn't in the Dow Jones Industrial Average. Why not?

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The 12-year-old social network is getting harder for the Dow's overseers to ignore - an elephant in the room after adding almost $100bn in capitalisation since the average's last reshuffling. At $323bn (€284bn), Facebook is larger than 27 of the 30 Dow members and, aside from Alphabet (Google's parent) and Berkshire Hathaway, the biggest omission. Add to that a digestible share price that would avoid the distortions that keep Google's parent and from being added.

"Facebook is sort of staring at you like, 'Why isn't that in there?"' said Richard Moroney of Horizon Investment Services in Hammond, Indiana. "It's the leader in its industry, maybe it's expensive and it's a stock people are divided on whether it's really worth that price, but it's not ridiculous any longer."

At the same time, barriers exist that could be insurmountable, illustrating the challenges overseers face in deciding how soon to bless an industry such as social media. Compared with other members, Facebook is young with relatively low revenue and twice the valuation of other constituents. Its dual-class structure annoys some governance experts. Besides that, the Dow already has a heavy weighting in tech, and might be better off waiting for Alphabet or Amazon to split their shares before adjusting it.

Created in 1896, the price-weighted Dow Jones Industrial Average is intended "to provide a clear, straightforward view of the stock market, and, by extension, the US economy," according to the S&P Dow Jones Indices website.

Some critics perceive the index's overseers as old fashioned, preferring companies that make physical goods over those in the so-called "new" economy, and say they're often late to change.

"The owners may be a little gun-shy - their changes in the past 15 years have been poorly timed from an investor's perspective," said Moroney, who also edits the Dow Theory Forecasts newsletter.

Apple, the world's largest company, was added only a year ago after its stock peaked and underwent two splits. Meanwhile, the owners have let struggling members try to right themselves before removing them, he said.

Facebook, which went public in May 2012, would be the youngest member of the gauge, with a shorter public tenure than Visa. With 2015 fiscal year revenue of $17.9bn, it would be the second-smallest company by that measure, ahead of Visa. The world's largest payments network went public in 2008 and was added to the Dow five years later.

At 88 times earnings in the last four quarters and 36 times analyst estimates for 2016, its valuation isn't for the faint of heart. The closest correlatives are Visa, which trades on those bases at multiples of 35 and 28, respectively, and Chevron, at 28 and 67.

David Blitzer, chairman of the S&P Dow Jones Indices index committee, declined to comment about the possibility of Facebook's inclusion. Committee members continually monitor the major US companies and meet twice a year, most recently in March, he said.

"When we meet and when we do something are unrelated," Blitzer said. "Most of the changes are driven by some sort of corporate event."

A corporate event is happening: the merger of Dow Chemicals and Dow average member DuPont, which was announced in December, awaits regulatory and shareholder approval. Only two changes have happened since the gauge was taken over in July 2012 by S&P Dow Jones Indices, a joint venture of McGraw Hill Financial and CME Group.

While making odds on who will be kicked out has gotten harder after the ownership change, American Express is likely to be on a "watch list" given the company's struggles in recent years, Moroney said. "I wouldn't be surprised to see it get booted."

Shares of the New York-based firm have tumbled 37pc from an all-time high in July 2014, the benchmark's worst-performer during that period. AmEx was added in 1982 on the heels of a decades-long transformation, going from a travel business that offered some financial services, to a fully-fledged financial services company.

It's now the biggest credit-card issuer by purchases - but it's struggled after losing key co-brand partnerships (including Costco Wholesale, JetBlue Airways and Fidelity Investments), and has moved to increase lending in the US.

A spokeswoman for American Express cited the company's policy not to comment about market speculation or rumours. "As the economy evolves, I think it's fair to do replacements. For American Express, that business is definitely changing - it may become the next Radio Shack of finance," said Michael Chadwick, who manages $150m as chief executive officer of Chadwick Financial Advisors in Unionville, Connecticut.

"Facebook is in a totally different industry, but that's not necessarily a bad thing because that's where the economy is going."

Other internet champions are too expensive for inclusion - though that could change if they split. Currently trading at more than $760 a share, Alphabet would make up more than 25pc of the index if it went in today.

Back in 2013, Blitzer cited Google and Apple's then $494 a share price as too high even given their obvious importance to the economy.

"The prices of their stocks are so high that putting Google in would completely distort the index and it wouldn't work," he said at the time.

To be sure, the internet isn't the only part of the economy going unrepresented. There's never been a cable-television provider or biotechnology firm in the Dow and there currently are no food makers after Kraft Heinz was removed in 2012.

Inclusion in the Dow doesn't always help components. Several stocks - including Alcoa - flourished after being dropped, Chadwick said. While Facebook's omission seems glaring, the company's youth could be a deterrent, he said.

When Facebook was founded by Mark Zuckerberg in 2004, more than half of the current Dow's constituents already were in the gauge, with General Electric's membership dating back to 1896.

Speculating about what's next is fun from the sidelines and also indicative of how the owners perceive the current economy, Chadwick said. "There's a lot of meat on this bone, and a lot of different directions this could go."


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