Is index inclusion all it’s cracked up to be? Via Investing.com

Investing.com — A company’s inclusion in a major stock index like this is often seen as a hallmark of success, signaling to the market that the company has achieved a certain level of financial stability and growth.

However, analysts at Strategas Securities in a note suggest that the reality may not be as simple as it seems.

One of the most compelling findings from Strategas Securities’ analysis is the stark difference in performance of the companies that led to their inclusion in the S&P 500 compared to their subsequent performance.

The study examined 160 companies that were added to the S&P 500 between 2015 and 2024. “On average, the names outperformed the S&P 500 by +4800 bps, only slightly better than the -66 bps of underperformance emanating 12 months after inclusion, after as mentioned in the previous point,” said analysts at Strategas Securities.

This outperformance could be attributed to the “buy the rumor” phenomenon, where investors anticipate a company’s inclusion in the index and drive up the stock price in the months leading up to the official announcement.

The listing itself is often seen as a validation of a company’s growth and stability, leading to increased investor interest and, consequently, an increase in share price.

However, the picture changes dramatically after inclusion. The same study found that in the 12 months since their inclusion, these new constituents underperformed the broader index by an average of 66 bps.

This underperformance is surprising, especially given that companies typically need to demonstrate improving fundamentals to meet eligibility requirements for index inclusion.

Post-listing underperformance raises questions about the long-term benefits of adding to a major index. It suggests that much of the positive impact of inclusion is already assessed by the time of inclusion.

Additionally, the increase in stock price leading up to the listing could lead to overvaluation, making it difficult to sustain the stock’s performance afterward.

The analysis also explored the performance of companies that were removed from the S&P 500, excluding those that were acquired. “On average, these names underperform the index by ~-825 bps in the 12 months since exit,” the analysts said.

This is not entirely unexpected, as delisting often reflects a deterioration in a company’s fundamentals, which usually continues after the exit.

Investing in an index does not guarantee sustained outperformance, as Strategas Securities explains. The “buy the rumor, sell the inclusion” phenomenon seems to be at play, where the market reaction to the anticipated inclusion is much more positive than the actual benefits of the inclusion itself.

For long-term investors, this suggests a need for caution and a more nuanced approach when assessing the impact of index inclusion on a stock’s future performance.

Additionally, the poor performance of companies after the exit underscores the importance of maintaining solid fundamentals.

While inclusion in a major index can provide a short-term boost, companies must continue to demonstrate solid financial health to sustain long-term success.