With trillions of dollars invested in index funds, decisions about changes to the most popular benchmarks mean a flurry of activity for stocks. Most of the time, big index changes are relatively few and far between. But this week, you'll see a huge shift in some of the most-followed indexes -- and the big question is how the individual stocks that are making big moves will fare in their new homes.
Standard & Poor's announced last week that it would make several changes to its large-cap S&P 500 index, as well as its MidCap 400 and SmallCap 600 benchmarks. Although a few of the changes have already taken effect, most of the moves are effective as of Friday's close.
Why the big changes?
To understand why S&P is making these moves, you first need to look at the respective investment objectives of the three indexes. According to McGraw-Hill, the S&P 500 is the world's most-followed stock market index, tracking the biggest companies in the U.S. stock market. The mid-cap and small-cap indexes aren't quite as popular, but they serve the equally important purpose of helping broaden the reach of investors' portfolios by providing company-size diversification. In total, about $1.25 trillion tracks S&P indexes.
Over time, though, stocks change. Often, young stocks begin as small caps and grow steadily into mid caps and then large-cap stocks -- and along the way, they often get assigned to S&P's small-cap index, only later to be reassigned to the mid-cap index and then eventually to the S&P 500.
Conversely, some stocks go the opposite direction. Once-dominant large caps can fall out of favor, steadily losing value until their market caps are more similar to those of up-and-coming small caps than those of their former industry-leading peers. In those cases -- and in order to make room for the up-and-comers, index providers like S&P have to downgrade out-of-favor stocks to indexes for smaller market caps.
Winners and losers
This time around, S&P is making a relatively large number of market-cap-related shifts. Some of the changes are extreme. Here's a list:
- AK Steel (NYSE: AKS ) will drop all the way from the S&P 500 to the SmallCap 600. The double-drop is necessary to reflect the steelmaker's market cap, which has declined precipitously since the company replaced Countrywide in the S&P 500 in mid-2008.
- Auto-parts maker BorgWarner, pharma stock Perrigo (Nasdaq: PRGO ) , and discounter Dollar Tree are all moving up to the S&P 500, while chip-equipment maker MEMC Electronic Materials (NYSE: WFR ) and Monster Worldwide (NYSE: MWW ) move down to the MidCap 400.
- Moving up from small-cap to mid-cap status are Regeneron Pharmaceuticals (Nasdaq: REGN ) , which got its macular degeneration drug approved last month. World Fuel Services (NYSE: INT ) and HMS Holdings are also making the move up.
- Finally, homebuilder Ryland Group will move down from mid-cap to small-cap status, following the general trend of the housing industry. Going with it are for-profit educator Career Education (Nasdaq: CECO ) and REIT Cousins Properties.
How can I make money off this?
You can bet that on Friday, many institutional investors will try to take advantage of the index funds that have to frantically sell shares of the dropped companies and buy shares of the newly added stocks. Near the close, you can expect huge volumes of shares as those institutions finalize their index-related moves.
But as far as profiting from the moves, it's definitely not a sure thing. For instance, earlier this year, the Russell 2000 did its annual rebalancing, with plenty of hot small caps getting added to the index while other falling stars found themselves booted out. Yet it definitely wasn't the case that shares of the new additions universally got bid up while deleted stocks fell -- plenty of stocks involved barely moved at all, while others went in the opposite direction from what many would have expected.
Stay tuned
For the most part, index changes are just a curiosity for regular investors. If you own the right stocks, it doesn't really matter what index they're part of.
But that only raises the bigger question: Do you own the right stocks? You'll find one great prospect in our newest special report, "The Motley Fool's Top Stock for 2012." This report is absolutely free, but you won't want to wait long to find out about it. Click here and don't miss out.
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