I want to examine with you today the effects of the Index Funds on individual stocks and how we as value investors can identify opportunities as they occur.
Lets first explain the concept of Index Funds, In the early days the only way for investors was to buy individual stocks of companies or a group of stocks , until 1976 John Boggle introduced the first ever index fund , the Vanguard 500 , which tracks the S&P500 Index (largest profitable 500 companies in the US) , by buying that Index fund investors were able to match the market performance without the need to study individual stocks or pay massive fees for money managers , at least that was Boggle’s intent at the time , to allow retail investors to compete with the pros.
50 years later , we have over 5,000 funds globally , with AUM (Assets under management) rising from 204 billion USD in 2003 to over 10 trillion USD now , and for these fund managers having inflows of money coming into their funds they must accommodate it by finding places to park that cash in the form of buying stocks. Let us explain more how some of these funds operate to get a better picture of the effect on individual stock performance.
A fund consists of a group of stocks based on a specific criteria , this criteria can be fixed or changing over time , allowing new companies to enter into a fund and other companies to be dropped from a fund in case it no longer meets the criteria. Examples of criteria can be profitability , industry or sector , market cap , geographical , etc.
When more funds are added to a fund this money is channeled into this basket of companies with the same weight as currently existing, regardless of how these companies are currently performing (both fundamentally and on a price basis) and hence if a company is already over priced it will keep getting more expensive as money flows into it by these funds and vice versa.
Now to examine my opinion on Intel (Tickr : INTC) following the past year’s company performance and announcements as well as the impact of the index funds it is included in (336 at the time of writing this article).
Checking the stock price gain of 3 of the largest semiconductor companies (AMD – INTC – NVDA), 2 of which were considered darlings of the post pandemic market exuberance led on by the stimulus packages finding their way into equities , we find that the 3 companies gained (292% , 49% & 541%) respectively since the March 2020 lows to the highs in late 2021, during a time where the S&P returned 105% and the VanEck Semiconductor ETF returned 209% , note that all 3 stocks are included in both ETFs mentioned.
While it is clear Intel didn’t enjoy the same exuberance on the way up , let us see how the 3 companies performed since the beginning of 2022 and the bear market that was caused by the Federal Reserve Bank interest rate hikes.
As we can see in the above table , during 2021 when Intel announced its 5 year expansion plans , the share price dropped 15% while those of AMD & NVDA continued their meteoric rise , but once the bear market started, in every incident of bad news or market selloff all the companies were affected. If we consider that at the beginning of 2022 Intel yielded almost 10% annual return at a PE ratio of 11 , while AMD & NVDA yielded 2% & 1% at PEs of 45 & 85 respectively.
Hence I don’t think INTC should have dropped that much since the beginning of the year, and it was sold with most of the market and its competitors (all 3 companies AMD , INTC & NVDA are down 65% from their respective 2 year high) to a point where the price is now too cheap to ignore , trading currently at a PE of 5.5 while AMD & NVDA are at 25 & 35.
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