In the U.S., winners get trophies and parades, while losers go away to think about what went wrong. In 2020, Apartment Investment and Management (AIV) was removed to make room for Tesla, Inc. (TSLA) in the S&P 500 index. It was expected that AIV’s management would fade away while Tesla got extensive coverage. However, in the six months after Tesla replaced it, AIV had an 80% better relative return. While AIV, like the rest of the real estate industry, later faced challenges as interest rates spiked in the early 2020s, its stock price is still up about 60% since then. And AIV isn’t alone. Newly added S&P 500 companies often struggle under expectations, while outcasts historically outperform the market by up to 5% annually over the next five years.
What happens when the S&P 500 adds or removes stocks? Being included in the index means masses of passive investors will buy a company’s stock and it boosts visibility and reputation. Being removed signals a company is no longer considered one of the largest or most important publicly traded firms. Research shows that companies removed from the S&P 500 tend to outperform the market. A study by Research Affiliates found that stocks taken out between 1990 and 2022 outperformed added ones by over 5% annually in the five years after.
Stocks that are removed from indexes often experience an initial decline in value. However, over time, these stocks can recover and provide better returns as the market corrects its overreaction. Contrarians find value in these beaten-down stocks, leading to a bounce back in share prices.
When a company is removed from the S&P 500, it is often met with a parade for additions and a funeral for removals, creating emotional overreactions that can lead to investment prospects. The ‘Index Effect’ suggests that stocks dumped by the S&P 500 might perform well afterward, as the initial bump in stock prices for those joining the index may not be as significant as previously thought. Joining the S&P 500 is akin to having a spotlight on your company, increasing visibility, media coverage, and analyst attention. This can boost a company’s public image and credibility. Conversely, removal from the index can be seen as a red flag, leading to a decline in investor confidence and negative sentiment. A study found that investing in an index of S&P 500 outcasts from 1991 to the end of 2023 would have yielded an average annual rate of 14.0%, compared to 10.6% for the S&P 500. This means that $100 invested over 33 years in the outcast index would grow to about $7,500, while the same investment in the S&P 500 would result in $2,800. Despite the belief that removal from the S&P 500 will inevitably cause a company’s share price to fall, especially in the initial months, some pundits recommend avoiding these stocks. This includes CNBC’s Jim Cramer, who advises caution.Jim Cramer advises against attempting to ‘catch a falling knife’ when a stock is expelled from the S&P 500, suggesting that historically, the odds are against such an endeavor. According to him, if Standard & Poor’s deems a stock unworthy, investors should likely follow suit.
The ‘Index Effect’ has long been a topic of interest on Wall Street. Research from the National Bureau of Economic Research, along with other data analyses, shows that in the 1980s and 1990s, there was a significant index effect. Stocks added to the S&P 500 experienced strong, positive, and abnormal returns—about 3.4% in the 1980s and 7.6% in the 1990s. Conversely, stocks removed from the index saw steep declines—about -4.6% in the 1980s and -16.6% in the 1990s.
The S&P 500 index is rebalanced quarterly, typically on the third Friday of March, June, September, and December. However, studies from the 2000s indicate a substantial decline in the index effect. By the 2010s, stocks added to the index saw only a small 0.8% rise, with some studies even suggesting a minuscule 0.1% increase, while stocks removed had almost no abnormal returns at -0.6%. In the 2020s, the differences between being in and out of the index appear to be statistically insignificant.
Several factors have been proposed to explain this shift. Market efficiency has improved, with the market better accommodating demand shocks from index changes. Institutions now provide liquidity more effectively, reducing price pressure. An increase in migrations between indexes, particularly between the S&P MidCap 400 and the S&P 500, has led to offsetting trades from index-tracking funds, resulting in smaller net demand shocks.
Predictability of index changes has grown with the rise of indexation, allowing arbitrageurs to front-run index announcements, thus reducing the price impact when the actual change occurs. Additionally, market liquidity has improved significantly, with bid-ask spreads falling, enabling the market to absorb large trades more efficiently and further reducing the price impact of index changes.The S&P 500 is designed to represent the largest and most influential companies in the U.S. economy. To maintain this status, the index must adapt to market changes by adding companies that better reflect the economic landscape and removing those that no longer meet the criteria. This selection process is overseen by a committee at S&P Global, which meets quarterly to evaluate companies in the index and make adjustments as needed.
Changes to the index are typically announced with several days’ notice to give index funds and other market participants time to prepare.
For a company to be considered for the S&P 500, it must meet several requirements. These include an unadjusted market cap of at least $18 billion, at least 10% of shares available to the public, positive earnings in the earlier four quarters, adequate liquidity, being a U.S. company, being a publicly traded company for at least 12 months, and contributing to the balance of sectors held within the index. However, meeting these requirements doesn’t guarantee inclusion; the S&P 500 committee exercises discretion to ensure companies selected are truly representative of the large-cap U.S. market. More immediate action can be taken if a company is taken over, delisted, or files for bankruptcy. In such cases, the stock would be immediately removed from the S&P 500 and replaced with another company. Previously, those removed from the S&P 500 did better than in the last decade, at least in terms of outperforming the index. This is mainly because of the outsized performance of tech stocks included in the index and rotation away from value investing. Here are 35 stocks removed from the S&P 500 that have outperformed the index. As of market close on Nov. 6, 2024, here are a few standouts: Zions Bancorporation N.A. Removal date: March 18, 2024 Share price performance since exclusion: 52% S&P 500 performance since exclusion: 15% Sentiment in regional banks took a hit in 2023 after Silicon Valley Bank and First Republic went out of business. Salt Lake City-headquartered Zion Bank got caught in the crossfire, shedding value and eventually getting kicked out of the S&P 500. Zion’s downtrend turned out to be short-lived. An improving economic outlook and the U.S. Federal Reserve’s move to cut interest rates have since boosted the sector, along with Zion. Lincoln National Corporation Removal date: Sept. 18, 2023 Share price performance since exclusion: 42% S&P 500 performance since exclusion: 33% A challenging couple of years for Lincoln Capital led its share price to plummet and market cap to fall way below the S&P 500’s threshold. The life insurer was another firm affected by Silicon Valley Bank’s collapse. It also faced an uptick in pandemic-related mortalities and a host of other challenges, all of which weighed on its balance sheet and left it in a precarious financial position. The company has since been in recovery mode. Business has been improving, management has a better handle on costs, and investors have begun to notice, bidding the once-downtrodden shares up significantly over the past year. Lumen Technologies Inc. Removal date: March 20, 2023 Share price performance since exclusion: 262% S&P 500 performance since exclusion: 51% Lumen Technologies has come some way since getting booted from the S&P 500 in March 2023.A telecom company’s previous decision to avoid the wireless market in favor of expanding its wireline business through mergers and acquisitions negatively impacted its financial performance, leading to increased debt, suspended dividends, and a decline in market capitalization. This resulted in the loss of its S&P 500 status. 2223Lumen is actively enhancing its enterprise offerings, targeting large and midmarket enterprises in North America, and utilizing new partnerships to support AI network capacity. The surge in artificial intelligence (AI) and several contract wins, including with Microsoft Corp. (MSFT), have boosted sales and cautiously improved investor optimism about the company’s future prospects. PVH Corp., removed from the S&P 500 on Sept. 19, 2022, has seen its share price increase by 86% since exclusion, outperforming the S&P 500’s 54% performance over the same period. PVH, known for its brands like Calvin Klein and Tommy Hilfiger, faced challenges due to changing consumer preferences, rising post-pandemic interest rates, and issues within the retail clothing market. However, with falling borrowing costs and easing recession fears, investors are reevaluating the company’s diversified portfolio of popular brands, global reach, cost discipline, technology investment, and undervalued stock. The Apartment Investment and Management Company was removed from the S&P 500 on Dec. 21, 2020, replaced by Tesla. Despite this, AIV has shown better performance at times. As a real estate investment trust, the company acquires, manages, and redevelops residential apartments, benefiting from increased real estate demand and falling interest rates. The S&P 500 can add or remove companies at any time, with quarterly rebalancing being the most common period for changes. The committee overseeing the index can make alterations at any moment, especially in cases of takeovers or delistings. In 2024, stocks removed from the S&P 500 included American Airlines Group (AAL), Etsy Inc. (ETSY), Bio-Rad Laboratories (BIO), Robert Half Inc. (RHI), Comerica Inc. (CMA), and Bath & Body Works Inc. (BBWI). Stocks added to the S&P 500 in 2024 were Amentum Holdings Inc. (AMTM), Palantir Technologies Inc. (PLTR), Dell Technologies Inc. (DELL), and CrowdStrike Holdings (CRWD). The number of companies that fall out of the S&P 500 each year is not fixed and varies annually.
For example, in 2024, 12 companies were removed. And in 2023, 15 companies got the boot.
The Bottom Line: When a stock gets removed from the S&P 500, some investors think of heading for the exits. However, this knee-jerk reaction could mean leaving money on the table. While conventional wisdom suggests avoiding these corporate outcasts, historical data reveals a surprising twist. Companies removed from the index have often staged impressive comebacks, overall outperforming the market by as much as 5% annually in the five years following their removal. This counterintuitive pattern highlights a fundamental principle of investing. The best opportunities often emerge when everyone else is running in the opposite direction. While getting booted from the S&P 500 can trigger automatic selling by index funds and negative headlines, it can also force companies to make tough but necessary changes. These stocks often trade at far less than their previous highs. Meaning less optimism is priced in and there’s more potential upside if the company turns things around.
