Dave Nadig's Index Inclusion Rulebook
Require maturity, profitability, true float weighting, and voting rights
- Difficulty
- Moderate
- Time to result
- ~months to results
- Steps
- 4
- Confidence
- 97%
The rulebook evaluates a newly public company across four gates before granting meaningful index exposure. First, a one-year trading history allows price discovery to develop beyond the launch cycle. Second, a year of trailing profitability demonstrates operating substance rather than relying solely on forecasts. Third, free-float adjustment limits the company's weight to the proportion of shares actually available to public investors, preventing a thin float from creating an outsized index position. Finally, non-voting shares are excluded so index capital does not reward ownership without governance rights. Together, these rules align index representation with investability, financial maturity, and shareholder power while reducing forced buying around highly promoted IPOs.
Origin
Dave Nadig proposed this rulebook while discussing how SpaceX's thin float and accelerated Nasdaq-100 admission could distort index investing on Masters in Business.
Core principles
- 01Let public trading establish a credible market price.
- 02Require evidence of operating profitability.
- 03Weight companies by shares genuinely available to investors.
- 04Exclude shares that provide no voting rights.
- 05Apply consistent rules regardless of an IPO's size or popularity.
How to run it
- 1
Require a Public Trading Record
Wait until the company has traded publicly for one year. Use that period to observe liquidity, volatility, disclosures, and price discovery outside the initial IPO cycle.
Pro tip Review performance around lockup expirations and quarterly reports rather than relying on the offering price.
Watch out A short waiting period can force index funds to buy into a temporary IPO premium.
- 2
Test Trailing Profitability
Require a full year of trailing profitability before inclusion. This establishes that the business has produced earnings rather than merely promising future scale.
Pro tip Use consistently defined reported earnings across all candidates.
Watch out Changing the profitability test for a celebrated mega-IPO undermines rule consistency.
- 3
Apply True Free-Float Weighting
Calculate the eligible index position from the percentage of shares genuinely available for public trading. If only one percent is floated, recognize only one percent of the company's nominal value.
Pro tip Recalculate the weight as lockups expire and the genuine float changes.
Watch out Artificial float multipliers can create forced demand far beyond the shares initially available.
- 4
Exclude Non-Voting Shares
Remove non-voting shares from eligible index capitalization. Tie passive ownership to securities that preserve shareholder governance rights.
Pro tip Inspect each share class separately before calculating eligibility.
Watch out Treating voting and non-voting shares identically can reward structures that weaken public shareholders.
In the wild
SpaceX floats only five percent of its shares. Under this rulebook, an index waits for a year of public trading, verifies trailing profitability, weights the company at its actual five-percent float, and excludes any non-voting classes. Its fame or trillion-dollar headline valuation does not earn an exception.
→ Index exposure reflects the shares investors can actually buy without manufacturing an immediate oversized wave of forced demand.
A newly listed software company floats 30 percent of its shares but remains unprofitable. Even with adequate liquidity, it fails the profitability gate and remains outside the index until it establishes a qualifying earnings record.
→ The same transparent standards govern both ordinary listings and mega-IPOs.
Common mistakes
Making Exceptions for Famous IPOs
Accelerating admission because a company is large or popular converts a rules-based index into an active marketing decision.
Weighting the Headline Valuation
Using total valuation without adjusting for free float exaggerates the investable size of a thinly floated company.
Ignoring Shareholder Voting Power
Counting non-voting shares directs passive capital toward ownership that lacks corresponding governance rights.
Is it for you?
Best for
It is best for index providers, investment committees, and investors comparing passive funds' inclusion policies.
Not ideal for
It is not ideal for strategies designed to capture speculative IPO momentum immediately after listing.
From the transcript
“companies would have to trade for a year.”
“They would have to have a year of trailing profitability, which is what the S and P currently has.”
“I would not count non voting shares.”
From the episode
At The Money: Is SpaceX IPO Breaking Capitalism?