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Looking for possible S&P 500 additions?

Posted by: Aaron Pressman on March 2, 2006

When I used to cover Washington, D.C., it was sometimes said that when a member of the House of Representatives was elected to the Senate that the average IQ of both bodies rose. I’m not sure I found reps to be any more intelligent than senators, but the thought came back to me this morning as I was reading some research that Lehman Brothers did on companies that graduate from S&P’s midcap 400 index to the S&P 500. As everyone knows, stock prices get a pop when it’s announced that they’ll be added to the S&P because of the zillions of dollars managed to mirror the index. And Lehman has identified some likely candidates.

The firm’s analysts first looked at what happens to companies that go from one index to the other. From the beginning of 2000 to the end of 2005, 84 stocks moved from the midcap to the large cap index. On average, they gained almost 5% on the day of the announcement relative to the market. But those same stocks then underperformed after that first day until they were actually added. In fact, you should stay away from those companies on the day their move to the S&P 500 becomes effective. On that day, they underperformed by an average of 1.5%.

Perhaps of more utility, Lehman tallied up some 10 likely movers including Legg Mason (LM), Peabody Energy (BTU), Sandisk (SNDK) and Noble Energy (NBL). As a means of calculating just how big a pop the stocks might get from the promotion, Lehman projected how many shares would likely be sold by funds indexed to the S&P 400 and bought by those indexed to the S&P 500. Then the firm compared the net number of shares likely to be purchased to typical trading volume in each stock. By that measure, Expeditors International (EXPD), Noble and Legg could see the biggest moves. Among companies not in the S&P 400 that could move into the S&P 500, even more outsized buying action is expected. On that list, Kimco Realty (KIM), Boston Properties (BXP) and Lamar Advertising (LAMR) would see the biggest surges.

Now apart from hedge funds and day traders, I don’t think it’s wise to buy a stock solely on the basis of its possible inclusion in the S&P 500. It’s certainly not much help if you’re investing for a long period, especially given Lehman’s data that companies added to the S&P 500 from the 400 will underperform. But it’s a fair data point to consider along with a stock’s fundamentals and investor expectations.

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Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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