Shopify Inc. headquarters signage in Ottawa on May 3, 2022.Sean Kilpatrick/The Canadian Press
Shopify Inc. SHOP-T will join the prestigious Nasdaq 100 index on Monday, which is clearly good news for the company. But is the news worth US$25-billion?
The Ottawa-based e-commerce software company will remain a solid fixture in Canadian indexes, including the S&P/TSX 60 index of blue-chip stocks, where it is the second-most valuable company behind Royal Bank of Canada.
Here, it rubs shoulders not only with RBC but Toronto-Dominion Bank, Bank of Montreal, Enbridge Inc. and … zzzzz.
No wonder investors are applauding Shopify’s inclusion into a basket of the biggest tech stocks in the universe. After Nasdaq made the announcement May 12, the share price rallied 13.7 per cent in one day.
It gained further ground on May 13 and 14, adding a total of US$25-billion to the combined value of Shopify’s outstanding shares – or its market capitalization – in just three days of trading.
No doubt, inclusion in the index will deliver wider recognition for Shopify, which resides well outside the spotlight that is now focused on the Magnificent Seven tech superstars.
With a market capitalization of US$143-billion as of Friday, Shopify is still a relatively small player next to the likes of Apple Inc. AAPL-T, Microsoft Corp. MSFT-T, Nvidia Corp. NVDA-T and Amazon.com Inc. AMZN-T
The market caps of that elite squad start at about US$2-trillion. Their combined weighting accounts for nearly 40 per cent of the Nasdaq 100 index.
Shopify will likely enter the index somewhere close to the top quartile – so, no slouch – and should attract more investor attention, especially if it moves up the ranks with solid growth.
In its latest quarterly results, released earlier this month, the company reported that its revenues rose 27 per cent year-over-year.
Its growth is outpacing the expansion of e-commerce, which reinforces the long-term bullish case for an expanding market for Shopify’s software. Greater visibility through the Nasdaq 100 can only help.
But in joining the index, Shopify will also get new shareholders delivered to its doorstep: passive investors.
These are exchange-traded funds and mutual funds whose sole purpose is to blindly track a benchmark, such as the S&P 500 and the S&P/TSX 60 index.
The passive approach comes with key benefits: It’s cheap and effective, based on academic research suggesting it is hard for stock pickers to outperform major indexes over the long term.
What’s more important – and relevant to Shopify – is that passive investing is a dominant force now. Globally, assets in passive funds recently surpassed assets in actively managed funds, up from a 1-per-cent market share in the early 1990s.
The Nasdaq 100 is a big deal within the passive investing universe. It provides instant exposure to many of the world’s fastest-growing companies.
It is also a strong performer. Over the past three years, it has outperformed the S&P 500 by nearly 30 percentage points.
When a stock is added to any index, passive funds must buy it. When a stock is added to a particularly high-profile index such as the Nasdaq 100, the buying activity is going to be significant.
“It’s not just a symbolic milestone, it has real market impact,” Phil Mackintosh, chief economist at Nasdaq, said in an e-mail.
He added: “Markets are good at pricing in known future flows, and index rebalances are one of the most transparent examples of that.”
The Invesco QQQ ETF, an exchange-traded fund that tracks the index, has assets of more than US$320-billion, up from about US$140-billion five years ago.
When the fund starts buying Shopify shares, it may end up directing nearly US$29-billion toward the stock, based on Shopify’s market cap and a likely 0.9 per cent weighting in the index.
Active investors, who have bid up Shopify’s share price before this torrent of passive money arrives next week, could be anticipating good things ahead for the e-commerce company as its profile rises.
The problem: The recent gains are well out of line with the typical upbeat reaction to index inclusion.
According to research from Nasdaq, stocks outperform the market by about 1 per cent on average over the five days prior to inclusion in the index. Just 64 per cent of new inclusions gain ground on the day of the announcement.
That makes Shopify a special case. Perhaps investors are betting that the company has a lot to gain from joining the Nasdaq 100. Or perhaps active traders are having a little fun at the expense of passive investors.