How to Trade the Latest S&P Additions

Stocks historically perform better after joining the S&P if they started with fewer analyst "buy" ratings

Senior Quantitative Analyst
Jun 20, 2018 at 6:18 AM
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Five stocks have recently been added to the S&P 500 Index (SPX), including social media giant Twitter (TWTR). Stocks tend to get a boost when it’s announced they’ll be added, probably due to a combination of increased notoriety, more brokerage coverage, and buying from passively managed funds. This sparked my interest about how stocks tend to behave once they’ve been added to the large-cap index.

Stocks Performance After Joining the SPX

The table below summarizes how stocks performed after joining the S&P 500. The second table below shows how the summary would look if you had invested in the index rather than the stock. A quick glance at the table shows that buying the stock would have given a slightly better return, but investing in the index would have been a lot less volatile with a higher probability of being positive.

In particular, the last row of the first table is interesting. That row shows the percentage of time the stock beat the index over the different time frames. It seems the shorter the time frame, the better chance the stock has of beating the index. When you get out to a year later, the stock was the better investment just 45% of the time. One theory is that the addition to the index generates some buying power, possibly inflating the stock price. After some time, the buying dissipates and the stock falls back to its “correct” level.

Chart 1 IotW SPX Joiners

Considering Overall Sentiment

Nothing jumps out at me, performance-wise, from the tables above. But what if I add on a layer of sentiment to the data? I did the same analysis as above, but I used Zacks brokerage data to separate the stocks by whether the sentiment was bullish, moderate, or bearish. I only considered stocks with at least eight analyst recommendations. The results were interesting.

The table at the top shows stocks that analysts were very bullish on, meaning at least 75% of the brokerage firms held a "buy" recommendation. Focusing on the one-year returns, these stocks averaged just a 2% return over the next 52 weeks. Additionally, only 32% of these stocks beat the index. I then compared those numbers with the table at the bottom, which shows stocks where less than half of the analysts had a "buy" recommendation. In other words, analysts were bearish on these stocks. Those hated stocks averaged an 18% gain, with 65% of them beating the index. Since 2010, brokerage sentiment has been a reliable contrarian indicator on stocks being added to the SPX.

Chart 2 IotW SPX Joiners

Calculating Recent Index Additions

Knowing what we know now, below is a list of stocks that have been added to the index over the past couple of months (and one that was added this week). TWTR, which I mentioned earlier, has 30 analysts covering it, with a mere 27% having "buy" recommendations. Based on the above analysis, this would suggest a good buying opportunity. On the other hand, FleetCor Technologies (FLT), which was just added this week, has 10 analysts covering the stock and every one of them recommends it as a "buy." Based on our study, it’s likely this stock will struggle.

Chart 3 IotW SPX Joiners

 

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