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Fundamental Indexes: A Snapshot In Two Stocks

Since I’ve been looking at fundamental indexes recently, I got the idea of doing a quick test. I currently believe Apple’s stock is exposed to far too much hype and may be overpriced, although the recent fall has helped it. So I looked up 3 US stock indexes to see how heavily they are weighted towards Apple stock and where it falls in their list, with the following results:

S&P 500: 3.62%, #1 holding

Vanguard Total Stock Market: 2.89%, #1 holding

FTSE RAFI US 1000 (Fundamental Index): 0.83%, position unknown because of the formatting of the list but the #1 holding, Exxon, has a weight of 2.99%

Which Index Rates Best?

Although no one has claimed that fundamental indexes make the right call on every single stock, the current weighting seems to show that Apple is still very over-priced. Since the RAFI 1000 has twice as many stock as the S&P 500 (yes, really) we can estimate that it would put as much as 1.66% in Apple if it was cut in half. In reality it would be a lot less than that because the 500 smallest stocks in the index don’t carry much weight. A more reasonable estimate would be that it’s about 1% of the top 500 stocks based on fundamentals. Of course the Total Stock Market has far more stocks. A RAFI index of 6000 stocks would have to hold less in Apple, maybe only 0.6%.

So based on those comparisons, Apple’s market cap (and thus stock price) may be 3.6x – 4.8x the reasonable value based on the last 5 years of fundamentals.

In moving away from the e-Series funds I’m replacing the S&P 500 with VTI since it is more diversified and includes smaller companies which has the happy side effect or reducing exposure to Apple as this shows. Switching to a fundamental index would go even further to correct this.

In an interesting twist, the S&P 500 and the RAFI 1000 both have nearly identical weights in the top 10 stocks at 18.6% while the total stock market index has only 15.4% in the top 10 stocks, making it more diversified. The RAFI 1000 seems to be more concentrated than the S&P 500 since it has the same top 10 weighting even with more stocks to choose from. That concentration may be part of the reason for the historical performance of fundamental indexes.

What About Blackberry?

Following my hypothesis that Apple and Blackberry are at opposite ends of the hype scale and one or both will revert to the mean, I did a test using the Canadian fundamental index. Unfortunately Blackberry isn’t included in the US index even though it trades on US stock exchanges, so we can’t get a direct comparison to Apple within one index.

In the Canadian fundamental index Blackberry is weighted at 2.02% of 89 stocks, compared to 0.41% of 239 stocks in the TSX capped composite index. If you look at only the top 89 stocks of the capped composite, Blackberry is 0.48% of those holdings. So the fundamental weighting is approximately 4.2x what the regular indexes are holding.

Doing an actual head-to-head comparison wouldn’t take too much. You could look up the last 5 years of sales, cashflow, book value, and dividends for the two companies, average those, and find out the relative values. Then by comparing that to the market cap difference (Apple is 55x larger than Blackberry) you could see how much the market is valuing the difference beyond the fundamentals. A very rough estimate based on the ratios found about is that Apple’s fundamentals would only be 2.8x – 3.2x those for Blackberry. I’m willing to admit Apple is currently 3x better but 55x is a stretch.

It’s no guarantee, but this looks like another sign that Blackberry’s future stock performance may be better than Apple’s. And this is after Blackberry stock has doubled from its low and Apple stock has fallen by 30% from it’s high. At those extremes Apple’s market cap was 157x that of Blackberry!

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