Being part of the in-crowd is important for teenagers -- but for stocks?
In many ways, being popular is even more important for leading companies. Just as going to the prom with the perfect date or getting invited to all the best parties may have seemed like the ultimate payoff back in high school, one measure of a stock's popularity can make a billion-dollar difference for shareholders.
The ultimate club
Being part of key market benchmarks like the Dow Jones Industrials or the S&P 500 has always been a mark of distinction for companies. Especially with the Dow, the idea is that if your company is strong enough to merit being one of such a select group of stocks, then it must be better than its competition. And although the difficulties of former Dow components like General Motors and Citigroup
The rise of index funds over the past 35 years, however, has added a practical element to the panache of benchmark membership. With more than $600 billion invested in index mutual funds at the end of 2008, according to the Investment Company Institute, being included in the top stock market indexes can mean a huge boost to liquidity and access to capital markets.
Getting the brush-off
In contrast, not getting most-favored index status can easily lead investors to infer a vote of no confidence from the institutions that oversee top indexes. For instance, Standard & Poor's recently announced that AOL, which will soon be spun off from Time Warner
Given that AOL will have a market cap of around $2.6 billion based on when-issued trading, it's not all that surprising that it didn't make the S&P 500 cut. But some much larger companies also haven't broken into the S&P ranks. Most notable are Visa
There are rational explanations for why some companies don't make it into market indexes. In Berkshire's case, its high-priced stock has made it impossible for the company to reach the trading volumes necessary to become part of the S&P 500. One key element of the company's proposed buyout of Burlington Northern Santa Fe
For Visa, its short history as a public company may be keeping S&P from opening the gates to the credit card giant, although it has met S&P's minimum requirements for months now. Moreover, MasterCard
The cost of popularity
Interestingly, despite the apparent benefits of being included in a major stock index, the payoff may not be as great as you might think. Back in September, Bespoke Investment Group noticed that Carefusion, which had recently been added to the S&P 500 as a spinoff from Cardinal Health, was actually underperforming the stock it had replaced, Manitowoc
Just as the inherent inanity of putting so much importance on a single night of high school persists, so too will the attention investors give to the lists of additions and deletions from popular indexes. On the whole, though, you shouldn't let index moves affect you too much. Becoming part of a major stock market index is more likely the result of a successful underlying business rather than the cause of a stock's success.
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Fool contributor Dan Caplinger was quite happy with his prom dates back in high school. He and the Fool both own shares of Berkshire Hathaway, which is a Motley Fool Inside Value pick and a Motley Fool Stock Advisor selection. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy actually likes being the team water boy.