The popular S&P 500(SNPINDEX: ^GSPC) market index is simple, right?
The index tracks 500 of the largest publicly traded companies in the United States of America. It is weighted by market capitalization. So all you need to do is sort a list of every American stock by market cap, keep the 500 largest ones, and there's your index. Who needs a research team at S&P Global(NYSE: SPGI) when you can do the same job with a basic stock screener?
Right?
The S&P 500 stock-picking criteria
Well, no. The S&P 500 is actually a good deal more complicated than that. S&P Global's methodology for its index family is nearly 70 pages long, with very detailed instructions for inviting stocks to the S&P 500. For instance:
- Each name must rank among the top 85% of the most valuable companies in America.
- They must be corporations with common stock on the public market, headquartered on American soil. The index does not include alternative asset types such as exchange-traded funds (ETFs), American Depositary Receipts (ADRs) for foreign companies, or master limited partnerships.
- The stocks must show reasonable liquidity, measured by the average daily trading volume as a portion of the publicly available float.
- They can't have more than 50% of the business value locked up in non-public stock classes such as restricted shares, private shares, or non-tradable preferred stock.
- Some companies have more than one share class, which S&P Global usually handles by raising the 500-ticker limit and including all additional share classes. But there's a special exception for Berkshire Hathaway(NYSE: BRK.A)(NYSE: BRK.B). The S&P 500 index consolidates Warren Buffett's company under its lower-priced Class B stock, leaving Class A out "due to turnover and liquidity concerns." Trading volumes tend to suffer when a single share costs $689,000, after all.
- In the end, there is nothing automatic about the selection process. "Constituent selection is at the discretion of the Index Committee and is based on the eligibility criteria," and the stated rules are actually just guidelines.
So there are 503 stocks in the S&P 500 these days. S&P Global just announced the latest version of its indices, moving three names up to the S&P 500 flagship while three others moved down to the mid-cap or small-cap lists.
The switch will take effect on September 23. Meanwhile, the smallest market cap in today's S&P 500 is custom e-commerce retailer Etsy(NASDAQ: ETSY) at $6.1 billion. Incoming index members Dell Technologies(NYSE: DELL) and Palantir Technologies(NYSE: PLTR) come with market caps in the $75 billion range -- but there are still four non-members on the market with even larger caps.
I tip my hat to technology heavyweights Dell and Palantir, who clearly deserve their seats at the S&P 500 table. But why didn't fellow large-caps Mercado Libre(NASDAQ: MELI) or The Trade Desk(NASDAQ: TTD) make the cut?
The Index Committee doesn't publish the specific reasons for each pick, and certainly not for the snubs. What follows is not an official statement but my own analysis.
Mercado Libre doesn't really live here
Latin America's largest e-commerce business may be technically ineligible for inclusion, having filed for incorporation in Delaware 25 years ago. But inviting this stock would follow the letter of the guidelines while trampling all over their spirit.
The index tracks U.S. companies, not the giants of South and Central America. Mercado Libre's executive offices are found in Montevideo, Uruguay. The company lists 18 countries as its principal target markets, not including the United States.
The stock is also lightly traded, and would rank among the 20 lowest daily trading volumes among today's S&P 500 members. That could be addressed with a quick stock split, since Mercado Libre's share price hovering just below $2,000 per stub. But I don't see how a split would outweigh this company's non-U.S. operating model.
Mercado Libre is a great company with a $101 billion market cap and robust financial growth. But it isn't a natural S&P 500 candidate in its current form. It would take a stock split and a North American expansion, and I don't see that combo happening anytime soon.
The Trade Desk could be next
It's a different story for The Trade Desk. The online marketing expert was founded in Ventura, California, and runs its business from the same neighborhood 15 years later. The United States accounted for 87% of the company's sales last year. This company is as American as baseball and drive-thru lunches.
There is no problem with the stock's market liquidity, either. The Trade Desk's shares are priced at roughly $100 with heavy average trading volumes. It is one of the most liquid stocks on the market today.
So why is The Trade Desk not an S&P 500 member yet? It should be a shoo-in with a $49 billion market cap! Sure, this $49 billion market cap pales in comparison to Dell or Palantir, but it's one of the largest American stocks that don't have a key card to the S&P 500 lounge.
But you have to draw the line somewhere. S&P Global updates its index rosters quarterly, and you rarely see more than three additions per announcement.
And the two largest additions in this week's update are tech stocks -- not exactly the same thing as The Trade Desk's digital advertising expertise, but it would have been a lot to include a third high-tech expert in the same review. This company drew the short straw once again, but might have better luck in three months, or next year.
Unlike Mercado Libre, The Trade Desk looks like a very likely S&P 500 addition in the near future. And it's one of my favorite tech stock to buy today, with or without a future in the S&P 500.
Should you invest $1,000 in The Trade Desk right now?
Before you buy stock in The Trade Desk, consider this:
The Motley Fool Stock Advisor analyst team just identified what they believe are the 10 best stocks for investors to buy now… and The Trade Desk wasn’t one of them. The 10 stocks that made the cut could produce monster returns in the coming years.
Consider when Nvidia made this list on April 15, 2005... if you invested $1,000 at the time of our recommendation, you’d have $630,099!*
Stock Advisor provides investors with an easy-to-follow blueprint for success, including guidance on building a portfolio, regular updates from analysts, and two new stock picks each month. TheStock Advisorservice has more than quadrupled the return of S&P 500 since 2002*.
*Stock Advisor returns as of September 3, 2024
Anders Bylund has positions in The Trade Desk. The Motley Fool has positions in and recommends Berkshire Hathaway, Etsy, MercadoLibre, Palantir Technologies, S&P Global, and The Trade Desk. The Motley Fool has a disclosure policy.
