How Is SpaceX (SPCX) Already the Largest of 3,372 Holdings in This $97.7 Billion Vanguard ETF?

After weeks of waiting, investment management firm Vanguard finally updated the holdings of its 48 passively managed equity exchange-traded funds (ETFs).

Unsurprisingly, Space Exploration Technologies (NASDAQ: SPCX) popped up in the Vanguard Total Stock Market ETF, the Vanguard Growth ETF, and the Vanguard Mega Cap Growth ETF, among others.

By far the biggest surprise was that, as of June 30, SpaceX is the No. 1 holding in the Vanguard Extended Market ETF (NYSEMKT: VXF), ahead of 3,371 other stocks.

This is no small ETF by any means -- the Vanguard Extended Market ETF has $97.7 billion in net assets and traces its inception date back to December 2001.

Here's why SpaceX is now the top holding of the Vanguard Extended Market ETF and how it compares to the other Vanguard ETFs that bought SpaceX in June.

Image source: Getty Images.

SpaceX is making waves in the ETF world

The Vanguard Extended Market ETF's 6,775,494 shares of SpaceX were valued at $1.158 billion as of June 30. The fund includes a blend of small- and mid-cap stocks, with a few large caps sprinkled in. So you may be wondering why a stock like SpaceX is in the ETF, given it has a $1.63 trillion market cap and is one of the 10 largest U.S. companies by market cap.

SpaceX's initial public offering was the largest in history based on SpaceX's valuation. But SpaceX raised just $75 billion by selling 555 million shares at $135 each and another $10.7 billion from underwriters with options to buy additional shares -- far less than its valuation. So the number of shares available for public trading on the Nasdaq -- known as the float -- is only around 5% of SpaceX's total shares outstanding.

Because SpaceX's float is such a small percentage of its market cap, the rules-based S&P 500 Completion Index that the Vanguard Extended Market ETF is modeled after probably classified SpaceX as something other than a megacap stock. This is why SpaceX was pole-vaulted to the fund's top holding in a matter of weeks.

These same market dynamics are why SpaceX makes up such a small percentage of funds like the Vanguard Growth ETF. If SpaceX were weighted by market cap, it would have a weighting similar to Meta Platforms at about 3.4%. Instead, SpaceX is just 0.29% of the fund, weighted by a multiple of its float rather than market cap.

The IPO wild west is just beginning

Float-based market cap weightings are effective because they act as a check-and-balance system on ETF demand. If SpaceX were weighted by market cap, then ETFs would artificially drive up its price, given how few of its outstanding shares are available for trading on the Nasdaq. But the pattern in which passively managed Vanguard ETFs are buying SpaceX showcases the imperfect system of megacap IPOs.

As SpaceX gradually unlocks shares starting Aug. 6, investors can expect it to make up a larger share of well-known ETFs like the Vanguard Growth ETF and Vanguard Total Stock Market ETF. But that larger float will also likely trigger SpaceX's removal from the Vanguard Extended Market ETF.

How ETFs are responding to SpaceX is a reminder to always understand what you're buying and why you're holding it. In the case of the Vanguard Extended Market ETF, I wouldn't be surprised if it dumped its entire SpaceX holding before the end of the year, but also had a short period where upcoming megacap IPOs like Anthropic and OpenAI would become top holdings, only to eventually be removed from the ETF.

Daniel Foelber has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Meta Platforms and Vanguard Growth ETF. The Motley Fool has a disclosure policy.