Index Investors: Prepare to Own Facebook

Facebook has drawn controversy ever since its initial public offering, and in the aftermath of its botched IPO, many investors swore they'd never own shares of the social-media giant. Yet thanks to the recent decision for S&P Dow Jones Indices to add Facebook to the S&P 500 effective after the market closes on Dec. 20, any investor who owns an S&P index fund will find themselves having to deal with owning a proportional stake in the company.

Almost two years ago, when Facebook first filed for its IPO, I made the not-very-challenging prediction that sooner or later, this day would come. In large part, it appears that everything has worked out much the way many foresaw -- albeit with some big road bumps along the way.

Facebook's winding road to index stardom
Ever since its IPO, Facebook was almost destined to become part of the S&P 500. Its IPO price implied an overall market capitalization of more than $90 billion, putting it well above the vast majority of existing S&P 500 stocks. Even at its worst post-IPO levels, Facebook remained a far larger market cap than most of its would-be peers in the index.

Since then, several other indexes had been less hesitant to add Facebook to their ranks. Russell's indexes were among the first to include Facebook as a constituent, and as various lockup provisions expired to expand the stock's float, Russell responded earlier this year by boosting the social-media giant's weighting in several key indexes. The Nasdaq 100 brought on Facebook as a member a year ago, giving shareholders in PowerShares QQQ the same conundrum that S&P index fund investors face today.

But S&P was reluctant to invite Facebook into the fold as quickly. The index has long had seasoning requirements, forcing companies to develop at least a short track record as a public company before gaining admission. Moreover, Facebook initially offered only a small portion of its overall shares, and S&P has traditionally avoided stocks with limited floats because of the liquidity needs of the institutional investors that track its indexes.

The inevitable spike
After S&P announced its move, Facebook shares soared 4% in after-hours trading as investors anticipated the need for index funds to buy the stock. That's another unfortunate example of the S&P's 500 record of timing, as index investors will now have to buy Facebook shares for more than $50 a piece when they could have spent less than half as much as recently as July.

Regardless, investors shouldn't be too upset at the move. Of every $100 they have invested in an S&P 500 index fund, their Facebook investment will amount to just $0.75 or so. That said, for many, that'll be $0.75 more than they ever expected to have invested in the social-media company.

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Fool contributor Dan Caplinger has no position in any stocks mentioned. You can follow him on Twitter: @DanCaplinger. The Motley Fool recommends and owns shares of Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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