A company’s inclusion in a major stock index such as the Dow Jones Industrial Average 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 Stratgas Securities point out in a note that reality may not be as clear-cut as it seems.
One of the most compelling findings from Stratigas Securities’ analysis is the significant difference in companies’ performance before they were included in the S&P 500 compared to their performance afterward.
The study examined 160 companies added to the S&P 500 between 2015 and 2024. “On average, the names outperformed the S&P 500 by +4,800 basis points, slightly better than the -66 basis points of underperformance that occurred 12 months after listing as noted in the previous bullet point,” analysts at Stratigas Securities said.
This outperformance can be attributed to the phenomenon of “buying the rumor,” where investors anticipate a company’s inclusion in the index and bid up its stock price in the months leading up to the official announcement.
The listing itself is often seen as an affirmation of the company’s growth and stability, leading to increased investor interest and, consequently, higher share prices.
But the picture changes dramatically after listing. The same study found that in the 12 months following listing, these new companies underperformed the broader index by an average of 66 basis points.
This poor performance is surprising, especially given that companies typically need to show improvement in fundamentals to meet eligibility requirements for inclusion in indexes.
The poor performance after inclusion raises questions about the long-term benefits of adding a country to a major index. This suggests that much of the positive impact of inclusion is already factored in by the time inclusion occurs.
Furthermore, a sudden spike in stock prices prior to joining the list could lead to overvaluation, making it difficult for the stock to maintain its performance thereafter.
The analysis also explored the performance of companies that were dropped from the S&P 500, excluding those that were acquired. “On average, these names underperformed the index by -825 basis points in the 12 months following their exit,” the analysts said.
This is not entirely unexpected, as exiting the index 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 Stratigas Securities explains. The phenomenon of “buy the rumors and sell the listing” appears to play a large role, where the market’s reaction to an anticipated listing is more positive than the actual benefits of the listing itself.
For long-term investors, this suggests the need to exercise caution and take a more nuanced approach when assessing the impact of index inclusion on a stock’s future performance.
Moreover, the poor performance of companies after the exit underscores the importance of maintaining strong fundamentals.
While inclusion in a major index may provide a short-term boost, companies need to continue to demonstrate strong financial health to support long-term success.
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