Thursday, December 31, 1998
DJIA 9228.29 -46.35 (-0.50%) S&P 500 1228.13 -3.80 (-0.31%) Nasdaq 2169.64 +2.69 (+0.12%) Value Line Index 914.77 +5.98 (+0.66%) 30-Year Bond 101 27/32 -21/32 5.13% Yield

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An Investment Opinion
by Louis Corrigan

S&P Changes as Sport

Investing is about finding great companies at fair prices, more or less. Still, it's easy to become fascinated by the gaming aspects of the market. There are rules both official and unofficial about how the market works, and it's both intriguing and even useful to learn them.

Today's game is "Changing the S&P 500," and the target match features America Online (NYSE: AOL), which is being added after market close today, and Venator (NYSE: Z), which is being dumped. Based on research conducted by economists Anthony W. Lynch of New York University and Richard R. Mendenhall of the University of Notre Dame, for the period 1989 through 1995, stocks going into the index gain an average of 3.2% on the day after the news of the change and an additional 3.8% before the change occurs. These stocks usually spike the day of the change (that is, today) as money managers mimicking the index rush to take positions. The jilted stock drops by 6.3% the day after the announcement and another 12.7% before the actual change. As I've discussed before, the growing importance of the S&P has actually exacerbated these swings.

Since December 22, when S&P announced this latest move, AOL has soared 18.1%, from $122 3/4 to $145, while Venator dipped 12.1%, from $6 13/16 to $5 7/8, before recovering to $6 3/4 today. Venator's rebound is interesting because the Lynch-Mendenhall study found that stocks deleted from the index experienced a permanent negative price effect of 14.1% to 15.7%. In other words, with a bunch of fund managers no longer obligated to own these issues, the demand curve shifted, cutting the price. However, the day after the S&P drops a stock, there's typically a recovery of several percentage points as the selling pressure ends. Given that Venator had already plunged from a 52-week high above $27 and much of the tax-loss selling had been done before the S&P news came out, the index-related selling appears to have enticed bargain hunters to bite, figuring all the bad news for the year was out and bounce was on the way.

AOL investors should note, though, that the Lynch-Mendenhall study also showed that stocks joining the index typically dropped by about 0.75% the day after being added and another 1.25% over the next week, though these issues still end up trading 5% above the levels seen just prior to the S&P's announcement. Merrill Lynch tracked index newcomers during the 1990-1998 period and found that these stocks underperformed the index for up to a month after being added, with the 30-day underperformance rising to 8.5% this year, in line with greater outperformance in the week leading up to joining the index. That suggests AOL could have a tough month ahead, relatively speaking.

One potentially mitigating factor, though, is that since the S&P index is market-cap weighted, and AOL is much larger than Venator, money managers may have to sell down their other index holdings to buy enough AOL. That could push the overall index down. At least, that's the speculation. It will be interesting to see if that's how the game plays out.


Wine and wine products direct marketer Geerlings & Wade (Nasdaq: GEER) poured gains of $2 3/16 to $9 7/16 after the company took "the unusual step of providing some details about our Internet plans." The details? The company hired a consultant to help revamp its site and will offer "hundreds of Bordeaux wines" on the site in January.

Internet portal Lycos (Nasdaq: LCOS) tackled $2 5/16 to $55 11/16 this morning as the company unveiled the "the official Web Site for Super Bowl XXXIII," the product of a partnership with the National Football League. Lycos will sell advertising space on the site, sharing revenue with the league.

First Banks America (NYSE: FBA) deposited $2 3/8 to $19 3/16 after 77% owner First Banks Inc. announced a Dutch auction tender offer for up to 400,000 of the company's shares with a price range of $16 1/2 to $21 per share. The company's stock closed at $16 13/15 yesterday.

Business Week's infamous "Inside Wall Street" column helped three stocks post gains today. Asynchronous transfer mode (ATM) switching products maker FORE Systems (Nasdaq: FORE) advanced $15/16 to $17 5/8 after the magazine quoted money manager Steve Dalton as saying he sees the stock in the upper $20s in six to 12 months. Dalton called FORE "an indirect way to play the strong Internet tide."

A rehashing by Business Week of the news that investors eagerly await the IPO of the Marketwatch.com financial news website meant a jump of $1 5/8 to $15 15/16 for Data Broadcasting Corp. (Nasdaq: DBCC), which created the site in cooperation with CBS Corp. (NYSE: CBS). Meanwhile, space module maker Spacehab (Nasdaq: SPAB) shuttled up $1/2 to $10 5/8 as "Inside Wall Street" quoted one analyst as saying the company will grow with the introduction of the International Space Station and an increase in non-governmental space research.

Disposable specialty medical products maker Maxxim Medical (NYSE: MAM) advanced $2 9/16 to $30 1/16 on reports that the company will be added to the Standard & Poor's SmallCap 600 Index.


In-flight catalog and online retailer SkyMall (Nasdaq: SKYM) fell $7 1/4 to $20 1/2 after co-founder and board member Alan Ashton resigned in part to "simplify his lifestyle." President and CEO Robert Worsley has acquired Ashton's 2.4 million share stake in the company, boosting his individual holdings to 54% of SkyMall's outstanding stock.

Northwest Airlines (Nasdaq: NWAC) skidded $11/16 to $25 1/4 after warning Wall Street analysts of a wider-than-anticipated fourth quarter loss due to business lost during a strike staged by its pilots in September. Higher maintenance costs are also expected to shear the airline's earnings in the period. Analysts expect profit per passenger to fall 5% in Q4 on top of a 3% increase in costs.

Information technology and systems integration services firm Computer Sciences Corp. (NYSE: CSC) was crunched for a $2 9/16 loss to $63 1/2 after the company came in third in the competition for a $1 billion computer privatization contract for the state of Connecticut. EDS (NYSE: EDS) ended up winning the contract, while Big Blue IBM (NYSE: IBM) finished in the number two slot.

Banking giant BankAmerica Corp. (NYSE: BAC) was knocked down $1 5/16 to $60 3/8 as analysts expect the company to take a $100 million ($0.03 per share) earnings bath in Q4 due to the lingering negative effects of its relationship with beat-up hedge fund and securities firm D.E. Shaw & Co. Previously, BankAmerica's Q3 earnings were cut in half after the bank wrote off a $372 million bad loan to D.E. Shaw.

Pacemaker and medical device maker Medtronic (NYSE: MDT) skipped a beat and lost $1 5/8 to $74 1/4 after The Wall Street Journal's "Heard on the Street" column cited analysts who took pot shots at the company's financial condition, suggesting the firm may use highly accretive recent acquisitions to keep its earnings growth alive and mask slowing growth in its core business segments.

Coin operated arcade and supermarket "skill crane" machines maker American Coin Merchandising (Nasdaq: AMCN) was wrecked for a $2 7/8 loss to $5 11/16 after saying slowing revenues and higher expenses related to recent acquisitions will result in Q4 EPS "significantly below" the $0.14 earned in Q3 and the $0.26 earned a year ago. The First Call mean estimate had called for EPS of $0.18 in the period. The company added that it expects its earnings to remain "depressed" in 1999.

Electromagnetic Sciences (Nasdaq: ELMG) was shocked for a $3 1/2 loss to $12 5/8 after the maker of wireless and satellite communications products announced that delayed orders will result in "near breakeven" operating results for Q4, missing the First Call mean earnings estimate of $0.31 per share. Also, the company said it will trim its workforce by 10% in the quarter. Fiscal 1998 EPS will likely come in between $0.65 and $0.70, lower than last year's $0.84 and short of analysts' expectations of $1.00.

A pair of yesterday's Internet-related highfliers fell back to Earth with a thud this morning, perhaps as day traders did some selling in anticipation of tonight's New Year's Eve excesses. Branded merchandise catalog and online retailer Genesis Direct (Nasdaq: GEND) gave back $2 1/4 to $7 5/8 after yesterday's 40% pop, while float-challenged financial data provider Track Data Corp. (Nasdaq: TRAC) slid $1 3/8 to $6 5/16 following a 102% advance on Wednesday.


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