T. ROWE PRICE Associates Inc.'s stock rose last week when the Baltimore-based mutual fund company was added to the Standard & Poor's 500 index, a closely monitored investing benchmark.
The day Price was named to the index, its shares leaped as much as 16 percent, and ended the day up about 6 percent. The index is made up of America's leading companies in the most important industries.
How important is it to be added to the index? Does it make a difference in the performance of a company's stock in the short term? What does it do over the long haul for a company?
Richard E. Cripps
Chief market strategist, Legg Mason Wood Walker Inc., Baltimore
It is definitely an honor. I'm sure they [Price executives] see it that way. It is a benefit to shareholders.
Being included in the S&P; 500, you are being included in an index that is increasingly being sought after by investors. You have created a demand for shares because it is part of an index that is being replicated by investors in increasing fashion.
The fact that they are included in the S&P; 500 probably gives them a kick of 10 percent, meaning their valuation; instead of trading at 10 times earnings, they trade at 11 times earnings. You also are on the radar screen for the bigger investors.
One of the things that is a very significant feature of this market that we have today is the larger you are in terms of a company, the greater your valuation is.
Equity derivative strategist, Merrill Lynch & Co., New York
Some companies will think it is the greatest thing, and other companies don't seem to understand the impact or aren't as wowed.
We consistently write about the S&P; effect. We estimate that there is $800 billion benchmarked against the S&P; 500. What that means is there is $800 billion in index funds, and those index funds have to replicate the S&P; 500.
When a company is added, essentially 8 to 10 percent of its total market capitalization will be held by buy-and-hold shareholders, namely the index fund managers. From the time the S&P; announces that a company will be added to the index to the actual addition day, which is generally four to five trading days later, there is a hyper-demand for those stocks.
Once a company is added to the S&P; 500, that hyper-demand obviously subsides and the companies on average tend to underperform the S&P; 500 for as many as 30 trading days.
Lots of studies go out further. Our belief is that after 30 trading days, fundamentals take hold and they are no longer trading on the index effect. The index effect isn't going to last forever.
Manager, Schwab Center for Investment Research, San Francisco.
I think it is nice to have. I don't view it as a big deal, something that should be the overriding factor for an investor as to when to buy the stock. People fixate on these little oddities that pop up in the market. Some can lose sight of the big picture.
We took a look at stocks that were added to the index in 1998. We wanted to see the stock price between the announcement and the effective date. We found that the average gain was about 10 percent between when the announcement was made and when it became part of the index.
What that tells me is certainly there is a desire on the part of fund managers, not just indexers, but other fund managers to own some of these stocks. There are probably other people out there who anticipate the demand by indexers and buy the stock first, hoping to resell it to the indexers later when it becomes officially part of the index. There definitely is a bump there. There is probably also some liquidity gains.
Manager, index funds, T. Rowe Price Associates Inc., Baltimore
I have spoken to people at Standard & Poor's, and they tell me that some companies that are clearly candidates to go in [to the index] call them periodically to try to find out when they are going to go in. I have heard that certain companies seem to bother them with the question, "Will we get added soon?" Around here, people seemed amused more than anything that we were going in.
S&P; 500 is a widely watched index. For the S&P; to say you are good enough to be in their index that is a nice thing to have them say about you. They will only add companies they think have solid balance sheets and that trade well enough to accommodate the extra trading that will happen.
There is definitely a short-term effect as you saw at T. Rowe. My take on it is the stocks get ahead of themselves, and, over a longer period, the market catches up with them, then eventually they do what they would have done anyway. Long-term, it goes back to the company's fundamentals.