S&P Overhauls Stock Classification Rules: $375 Billion in Funds May Be Forced to Rebalance, Growth and Value Stocks Face a Major Shake-Up

Stock News
10/24

S&P Dow Jones Indices has adopted new stock classification rules that will trigger a major reshuffling of growth and value stocks, according to a statement released by the index provider on Friday.

Under the new framework, S&P will incorporate intangible assets, projected earnings, and free cash flow into its methodology for determining whether a company is inexpensive relative to its share price. At the same time, the 12-month price momentum metric used to gauge a company's growth potential will be eliminated. These new rules were introduced following a recently completed consultation period and will take effect during the annual index reconstruction before market open on December 21.

The prolonged underperformance of value stocks prompted the index provider to reconsider its rules. This adjustment could force funds tracking the affected indices to rebalance their holdings to match the new index constituents. Bloomberg Intelligence analyst James Seyffart estimates that at least $375 billion in passive funds are linked to the impacted indices.

S&P's decision stems from a long-running debate over whether traditional value stock metrics remain effective. Researchers and fund managers argue that the extended slump in value stocks is partly attributable to flaws in the relevant metrics, particularly the price-to-book ratio. The adjustment aims to account for corporate spending on research and development as well as other internally developed assets, which under standard accounting rules are often treated as expenses rather than assets on the balance sheet.

Critics say this makes intellectual property-intensive companies appear overvalued, potentially preventing them from being included in value stock indices. S&P is not alone in considering rule changes. FTSE Russell is also re-evaluating its benchmark index's 50/50 split between growth and value stocks, driven by the growing market dominance of technology giants. That consultation period will conclude on December 11.

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