Thread by @travislundyasia

The Nikkei 225 is a weird and whacky index.

Locally it is sometimes referred to as the "Nikkei Dow" because it is price-weighted, like the Dow Jones Industrial Average.

Started many decades ago, the index was started by taking 225 stocks, adding up all the prices, and then

dividing by a DIVISOR to get to the index level on Day 1.

A stock's weight was price divided by the sum.

When one stock is taken out and replaced with another, you change the divisor on that day to make it the same as it would have been had the stock going out remained in.

All this was fine until Japan changed its Companies Act and decided that when a new company was formed, each share had a par value of ¥500 rather than the longtime value of ¥50.

That meant when a stock listed, it had fewer shares outstanding but a higher price. That meant the

Nikkei needed to change. So they did a price adjustment so that the Adjusted Price for each stock was (50 x Stock Price / Par Value). Then sum the Adjusted Prices and divide by the Divisor. Later the administrative minimum par value popped to ¥5,000 briefly then ¥50,000 so in the

1990s and early 2000s when a stock was listed, it usually had a hugely high price.

But the Nikkei had its system, so it worked.

Problem: as shares traded in round lots, as stock prices went up, the minimum trading unit went up. Sometimes they would get to be BRK-sized.

If a company split its stock to make it more affordable, that meant the price dropped. That meant its weight dropped so people had to sell. So companies were loathe to split.

Some did anyway.

The 3:1 Sony split in March 2000 was a huge event (back then there were technical

aspects to a split because your two new shares didn't actually get delivered until 2 months later - they traded as a when-issued stock with a different account type, annoyingly).

Then in April 2000, the Nikkei changed the rules to get rid of stodgy old stocks and bring in fancy

new tech stocks. 30 new tech stocks became 50+% of the index. 30 were deleted, and the other 195 stocks dropped their weight from 90% to 50%.

And there were 5 days to buy.

Incredibly, on the first day, because NDX had dropped 5% the previous Friday, the inclusion names fell.

Then over the next four days the inclusion names rallied close to 50%.

Then they went into the index.

Then they fell 20-30% vs the index.

And that was the top of the tech bubble.

Nikkei fell by half in 12 months.

In 2005, the Nikkei changed the rules on stock splits so that members which split their shares did not see their weights fall. They just adjusted the presumed par value on the open of the ex-date.

Which brings us to the choice of Sharp (6753) to replace Docomo....

Sharp fell from ¥2000 in 2006 to ¥200 in 205, and needed a bailout, which it got from Hon Hai. When it got the bailout, the price was struck lower because of further losses/problems and a bit of Terry Gou hardball.

When Sharp fell to negative net worth as of FY end-Mar2016, that

meant it would get pushed out of the TSE First Section. THAT meant it would get pushed out of the Nikkei 225. So it got pushed out at ¥92/share in July 2016.

Then it rallied 400% over a year, then fell a bit, and they did a reverse split 1:10 to lift the price to ¥4000+.

The stock was readmitted to TSE1 in 2018, and it went into TOPIX. All is fine. And for the delisting of NTT Docomo, Sharp was a shortlisted favorite.

So when Sharp was chosen today, it wasn't surprising to many. But the Nikkei Business Index Team applied a ¥50 par value to

Sharp, and THAT was a real surprise to most of us.

WHY? Because the Nikkei only uses price data from the TSE1. It has now become clear that it ignores corporate actions which happen outside the TSE1 as well.

What now?

Sharp gets squeezy. Sharpish.

And smart players will recognize the pattern for the next large TSE2 name which has reverse split its shares after being demoted...

which suddenly makes THAT trade more interesting...

To be clear, that stock is already known. It's Toshiba.

While Toshiba applied to be readmitted to TSE1 in April, it hasn't received approval yet. And if it gets approval, it wd likely be Sep 2021 or Sep 2022, at earliest, before it gets readmitted to N225.

Couple of odd corrections.
1) Even the Nikkei itself doesn't have records of how many stocks made up the index when it was first calculated. Later it was fixed at 225.
2) The requirement for a "par value" is a simple thing which comes from sections of the Commercial Code and

Companies Act (as amended through the years), and both were changed. Actual par value requirements were abolished in 2001, but if you had a good lawyer, one could actually issue no par value shares with the same voting rights, etc but it took 100 pages of docs and a really good

lawyer to get it done if you wanted to. Since the Nikkei required the adjustment to sort out the different par values used, the par value is now called the "presumed par value" or "deemed par value" and is used as a kind of single stock divisor to deal with stock splits and the

original par value.
3) The Dow Jones Industrial Average is functionally similar.
4) The weirdness here is because of how EITHER the Nikkei has just overridden their own rules on deemed par value, OR they have ignored the deemed par value adjustment because it happened while the

stock had been briefly demoted to the TSE2 for breach of the TSE1 Listing Rules in 2016 (at end-March 2016 they had negative net worth, which is grounds for immediate demotion from TSE1 to TSE2 when "confirmed") before getting the capital top-up in June-July 2016.

As an aside... this is, by the way, one of the main stories in the book Ugly Americans by Ben Mezrich. For people who were in the market at the time, there is a LOT which will be quite familiar and I know and worked with a bunch of them (but there is some storytelling going on).