Indicator of the Week: 10 Stocks to Watch After Nasdaq-100 Rebalancing

Stocks added to the Nasdaq-100 Index (NDX) tend to underperform over the following year

Senior Quantitative Analyst
Dec 21, 2016 at 7:30 AM
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The Nasdaq-100 Index (NDX) is made up of the 100 largest non-financial companies listed on the Nasdaq. Each December they rebalance the index, adding new companies and removing others. The rebalancing for this year just took place. Before we get down to specific stocks, take a look at the chart below, which shows the average returns of those stocks added and removed last year, in December 2015. You can see the stocks added to the index one year ago underperformed, and averaged a negative return over the past 12 months. The stocks removed from the NDX, meanwhile, outperformed the index in the shorter term, but over the full 12 months are more or less on pace with the index. This week I'll take a look to see whether there are any historical patterns in the returns of NDX additions and removals. 

NDX Additions and Removals chart Dec 20

Additions and Removals Since 2009: I went back to 2009 and found all the stocks added to and removed from the Nasdaq-100 each December for the annual rebalancing. The first table below shows how the stocks added to the index performed over the following year. The second table shows the same data for stocks that were removed from the NDX.

Based on the data seen here, the outperformance of the removals in 2015 was not an outlier. It looks like stocks removed from the NDX have a strong tendency to outperform those that are added. The stock market has been fairly strong since December 2009, so you can expect some good returns, but stocks removed from the index have increased an average of 25.7% over the next year. What's more, 72.5% of these returns are positive. In contrast, the stocks added to the NDX saw an average return of 8.6%, and just 56% of them were positive over the next year.

NDX Additions and Removals Returns Dec 20

The outperformance of the removed stocks makes some sense, from a contrarian perspective. These are stocks that have typically been beaten down over the previous year or several months. Hence, they lose their place among the largest 100 Nasdaq stocks. Additionally, the fact they are getting kicked out of the index could make investors sour on these stocks. The pessimism becomes climactic, and when the selling subsides, the stocks are left fundamentally undervalued. This leads to outperformance going forward for these stocks. At least, that's the theory. 

Here is a table showing the year-by-year breakdown of stocks added and removed. You can see the stocks removed from the index outperformed those added in six of the seven years, as measured by average return, with 2013 the only exception. Overall, less than one-third of the stocks added to the NDX outperformed the index over the next 12 months. Of those removed, 55% beat the Nasdaq-100. 

12-month Returns NDX Additions and Removals Dec 20

Recent Removals and Additions: The first table below shows the NDX removals in this year's rebalancing. According to the analysis above, these stocks could outperform over the next 12 months. I've also included the percentage of analysts that rank these stocks a "buy," according to data from Zacks. Analysts are clearly quite pessimistic on these stocks as of now.

The second table shows this year's additions to the Nasdaq-100 Index. Based on our data above, we would expect most of these stocks to lag the index over the coming year. 

NDX Additions and Removals 2016 Dec 20

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