What happened

Shares of Unisys (UIS -1.11%)Organogenesis Holdings (ORGO -2.23%), and Motorcar Parts of America (MPAA 5.28%) fell today as all three stocks were removed from the S&P SmallCap 600 index as part of its quarterly rebalancing.

The changes were announced after hours on March 3 and will take effect on March 20.

Unisys closed the day down 14.1%, Organogenesis lost 18.5%, and Motorcar Parts of America gave up 12.2%.

A stock chart with an arrow going down

Image source: Getty Images.

So what

There are several reasons stocks fall when they're removed from a major index like the S&P SmallCap 600. 

Generally, removal from an index is a reflection of the fact that a stock has generally underperformed and is no longer large enough to merit being part of the index.

Another reason is that mutual funds tied to the stocks in the index rebalance their holdings to reflect the changes in the indexes they track. If fewer index funds need to hold the stock, then the price will naturally drop, especially when those institutions sell.

Unisys, a diversified tech company, was a winner during the early stage of the pandemic, like much of the rest of the tech sector, but it has struggled more recently. Over the last year, the stock has lost 80% as revenue has fallen and profits have dropped sharply.

The company actually beat analyst estimates in its fourth-quarter earnings report from Feb. 22 as it swung back to revenue growth, with the top line inching up 3.3% to $557 million.

Unisys also delivered profit growth as well with operating profits under generally accepted accounting principles (GAAP) up from $44.5 million to $50 million. That momentum seems to indicate that the worst is behind Unisys, but with its market cap having fallen below $300 million on the rebalancing news to $284 million, it's not surprising to see it getting removed from the popular small-cap index. 

Shares of Organogenesis, a regenerative-medicine company, have also fallen sharply over the last year, down 73%, after rallying earlier in the pandemic, following a similar trajectory to other biotech stocks.

The company has seen revenue shrink recently as well, with sales down 10% to $115.5 million in the most recent quarter, at the low end of its guidance, with nearly all of its revenue coming from its Advance Wound Care segment. Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) fell by nearly half to $14.1 million. After today's sell-off, Organogenesis is now valued at a market cap of $313 million.

Shares of Motorcar Parts of America -- a manufacturer of replacement parts for heavy-duty trucks, boats, and other vehicles and machinery -- have been less volatile than Unisys and Organogenesis, but are still down 26.3% over the last year. The parts manufacturer has struggled lately, slashing its guidance as demand has slowed and revenue fell 6% to $151.8 million in its most recent quarter. Earnings per share also fell sharply from $0.16 to $0.05.

Management did say that it expected to return to sales growth in the fiscal fourth quarter, and it called for a strong fiscal 2024. However, it lowered its revenue guidance from fiscal 2023 to a range of $672 million to $680 million, which was well below the analyst consensus at $733.7 million.

Motorcar Parts now has a market cap of $224.2 million, below the general threshold of $300 million that's considered the minimum for small-cap stocks.

Now what

While all these stocks fell by double digits on the news that they were removed from the SmallCap 600, that shouldn't cause investors to change their investing theses.

Instead, they're better off focusing on the underlying fundamentals of each company. Though all three are struggling, Unisys and Motorcar Parts are expecting better times ahead.

Today's drop potentially sets up a recovery for these stocks, but they'll have to demonstrate consistent growth and solid profitability to bounce back.