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Are Index Rejects Smart Buys?

Dan Caplinger
January 29, 2013

Joining a prestigious stock index is a mark of a major achievement for most companies. For investors, though, you may be better off looking at the stocks that got removed from the index rather than the up-and-coming stocks that replaced them.

Late last month, the annual re-ranking for the Nasdaq 100 Index occurred, leading to 10 new companies getting added to the index. Yet some of the stocks that lost their place in the index have had extremely strong upward moves after the index changes, raising the question of whether index additions are a positive indicator or a contrary one.

The big movers
The Nasdaq 100 includes the 100 top non-financial stocks that are listed on the Nasdaq stock exchange. Every year, the index re-ranks Nasdaq stocks, making changes as necessary to reflect the ups and downs of the various components. So when stocks in the index do poorly, they run the risk of getting dropped in favor of high-performing stocks that just barely missed the list the previous year.

The index is a big deal, because substantial amounts of money track the Nasdaq 100. Most important, the PowerShares QQQ ETF (NASDAQ: QQQ) follows the index, and as one of the market's biggest ETFs with more than $32 billion under management, big changes to the index can result in massive short-term buying and selling pressure. And from a long-term investment perspective, joining the Nasdaq 100 can help a company gain new attention from investors who might not have been familiar with the stock previously.

As a result, some of the new picks have done pretty well. Western Digital (NASDAQ: WDC) is up 14% since the late-December rebalancing, as the prospects for enterprise-level hard drives have grown in light of the ongoing move toward cloud computing and big-data storage solutions. Catamaran (NASDAQ: CTRX) has continued its long upward trend, rising almost 8% as the