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greetings traders and welcome back to
another in-depth with chris episode in
today's discussion we'll be talking
about what happens when a stock is
introduced into the s p 500. once that
stock gets sucked up into the basket
what happens to the price of that stock
we'll cover all of that and more it's an
important thing to understand because
the more you know the more lucrative
opportunities will present themselves
now let's get going
many investors will tell you to never
forsake a good opportunity the thing is
you have to know where those
opportunities are to be able to take
advantage of them today we're going to
talk about when a stock is added to the
s p 500 because many traders use this as
an opportunity themselves and it's all
too common i find that traders don't
really understand the impact that
becoming an s p 500 included company has
on that company's stock price so the
first thing that we'll talk about is
what the s p 500 is s and p 500 stands
for standard and poor's 500 index we say
s p 500 for short and it's really a
market capitalization weighted index
that is comprised of 500 of the leading
listed companies in the us so in
layman's terms the s p 500 is the market
it includes some of the world's leading
companies from 11 sectors including i.t
healthcare consumer discretionary
industrials energy real estate and so
much more the broad diversification is
why the index is considered to be one of
the best reflections of the u.s stock
market performance it is worth noting
that the s p 500 doesn't necessarily
include the top 500 us companies by
market cap since there are a variety of
other criteria at play that decide if
something is going to be in it which we
are going to cover over the years the s
p 500 has become a global benchmark for
the world economy it's also one of the
most traded underlying assets we say
underlying because investors can't
directly buy the s p 500 instead they
can invest in it through other
instruments like futures contracts or
etfs that replicate the index's
performance since the s p was launched
on march 4th 1957 it has been steadily
growing with close to 7 000
gains to date during the first decade it
rose significantly to over 800
reflecting the economic boom following
world war ii today the s p 500 is
probably the most accurate indicator for
the state of the global economy and it
often dictates the moves of retail and
institutional investors
despite the importance of the s p 500
many don't fully understand exactly how
it works so let's focus on that for just
a minute to understand how it works we
should first start by saying that it
uses a market cap weighted method to
identify the 500 leading us listed
companies designed as a float weighted
index the s p 500 first takes the market
capitalizations of its constituents it
then adjusts them by the number of
shares available for public trading this
is also called free-floating shares
after this it accounts for each
company's market cap to compensate for
new shares issued or company mergers a
company's market cap is calculated by
taking the current stock price and
multiplying it by the outstanding shares
the weighting of each company in the
index is calculated by taking its market
cap and dividing it by the index total
market cap the construction model of the
index prioritizes companies with higher
market capitalization alternatively the
higher the value of the company the more
influential it is on the index's overall
performance it is important to note that
the 500 companies included in the index
aren't set in stone it is rebalanced
periodically and new companies
substitute those who are no longer
fitting the criteria
which brings us to our next subject why
things are added but also why things are
removed from this very exclusive club
the us index committee which is
comprised of full-time professional
members of s p dow jones indices staff
maintains the index each month the
committee will meet to review ongoing
corporate actions relevant to the index
constituents it also analyzes and
considers companies that are candidates
for inclusion
when it comes to selection and removal
criteria it's important to know that
companies aren't removed from or added
because of a future stock price
performance instead the committee tries
to keep the turnover low and make
adjustments only when a particular
company's financial status or overall
market conditions change
the complete list of the s p 500
inclusion criteria is pretty extensive
and it is available online if you want
to look it up but i'll give you the
quick rundown the first is they must be
a us listed common stock company now
there are exceptions that might apply if
their primary listing headquarters and
incorporation are all in the u.s or have
a domicile of convenience they must also
have a market cap of a certain size and
currently that is 13.1 billion at the
time of making this video they must also
be highly liquid companies and they must
also have a public float of at least 10
of its shares outstanding it must also
have an ipo at least a year earlier the
company must and it must also maintain
positive earnings for the most recent
quarter and also for the sum of its
trailing four consecutive quarters of
earnings
exclusions from the company on the other
hand how you get kicked out of the club
might happen because involvement in a
merger acquisition or significant
restructuring after which the company no
longer is meeting some of the criteria
we just mentioned or a substantial
violation of one or more of just about
any of the criteria we have also
mentioned so basically you must have
those criteria to be in and when you
lose those criteria you're going out the
door most likely
now for the portion of the video that
most of you are probably anxiously
awaiting and that is does the stock's
price go up or down after inclusion the
short answer is generally up this is
known as the s p 500 inclusion effect in
a nutshell studies have observed the
pattern that once a company is added to
the index it generates abnormal returns
the effect is evident mainly on the
announcement date and the actual date of
inclusion in a 1986 study it was
concluded that companies added to the s
p 500 between 1976 and 1983 experienced
a three percent increase in value on
average during the period from 1995 to
1999 that effect was even greater with
in excess of 8.32
gains for those added it should be noted
that the effect of gaining or losing a
place in a primary stock index like the
s p 500 is generally considered to be a
short-term impactor on the share price
that usually lasts about 45 days or less
the reason for the s p 500 inclusion
effect isn't that a company has become
more profitable or financially stable
overnight but no the most common
explanation is that the included
companies gain more awareness amongst
investors this gives them increased
analyst coverage and a sudden liquidity
influx this is also the reason why the
effect weakens over time but before you
go dump everything into the next company
that is included into the s p 500 you
should be aware that there was a recent
study that found that the inclusion
effect is becoming more rare nowadays
according to the findings companies
added to the s p 500 between 2011 and
2021 have experienced a median excess
return of only negative point zero four
percent now this was likely the result
of the structural changes in the
financial industry including the rise of
the etf market and the passive investing
ecosystem the national bureau of
economic research also found that the
stock increases in the short term linked
to the announcement of the index
inclusions have diminished in time the
lasting effect on price in recent years
has honestly been a little bit more
downward but that does not mean that
overall that has been the case or that
it will always be the case
so while it may not be wise to blindly
invest because a company is being
included in the s p 500 understanding
why companies go up and down is crucial
to making the most informed decisions
yes historically most companies have had
a positive effect that s p 500 inclusion
effect that we talked about and
companies that have not or done the
opposite it's often thought to be the
case because companies often times are
joining the s p 500 when they're already
at their highest valuation levels so
they don't have a lot more in the gas
tank to go so to speak at that moment
this is something to take into
consideration when you're doing your
technical and fundamental analysis of
the companies that you're looking to
invest in but other than that good luck
out there happy trading i'll see you all
very soon
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