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Why Index Rebalancing Can Be Good For AMC, Bad For GameStop Stock

The hot news in meme world is the addition of GameStop to the Russell 1000 index, while AMC missed out on the rebalancing and remains a small cap name. Wall Street Memes addresses the implications.

The news

GameStop stock  (GME) - Get GameStop Corp. Class A Report has recently been upgraded from a small-cap to a large-cap index. Previously a member of the Russell 2000, GameStop took advantage of meme mania to move to the Russell 1000 index of more richly valued stocks.

At the same time, AMC stock  (AMC) - Get AMC Entertainment Holdings, Inc. Class A Report, with a current market cap that is counterintuitively well above that of GameStop now, remains in the Russell 2000.

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Read more from Wall Street Memes: AMC Stock: Could Meme Mania Save The Company?

What is the Russell index rebalance?

Every year, around May or June, the Russell index updates its holdings. The refresh is based on a series of criteria involving market cap (the main one), price per share, trading volume, company structure, among others.

With each rebalancing, new demand trends for these shares emerge, which can mean high volatility in the short term. Rebalancing can favor value stocks, due to the more traditional financial profile of companies. Growth stocks, on the other hand, have a harder time moving up in the rankings, as they often have tighter margins and feature greater volatility.

Why did Game Stop enter the index and AMC did not?

The main criterion for addition to the index – market cap – has maximum and minimum limits. The maximum limit is $7.3 billion for the Russell 2000. The cutoff date for rebalancing the index was May 7. On that date, GME’s market capitalization was $10 billion, and the stock became eligible for promotion.

Figure 2: GME market cap chart.

Figure 2: GME market cap chart.

On the same May 7, AMC had a market cap of $3.8 billion (see chart below). This figure was not enough to make AMC eligible for the Russell 1000. Curiously, since May 7, AMC's value has climbed 85%. The company's market cap is now over $21 billion, even higher than GameStop's.

Figure 3: AMC market cap chart.

Figure 3: AMC market cap chart.

Why this can be bad for GameStop and good for AMC?

Theoretically, when being promoted or added to an index, an individual stock can benefit from becoming peers with other, more robust companies. As a result, investor demand can rise and trade volume can increase, making the stock more liquid and desirable.

In this specific case, a study found that companies that enter the Russell 1000 do not benefit much, as they enter the new index as one of the smallest companies in market cap terms. In the Russell 2000, this same company would have been one of the largest and most prominent.

For this reason, the addition of GameStop can be bearish at first. In the Russell 2000, the stock would remain one of the most important companies in the index. In the Russell 1000, it is just a small piece of the portfolio among giants.

In the case of AMC, the company is the current rock star of the Russell 2000, at the highest market cap within the index. Theoretically, small cap fund managers tend to view the top stock in the portfolio more carefully and with greater appreciation.

That said, meme mania has taught that theory can be quite different from practice. Having a meme stock become a peer to the largest publicly traded companies in the US can turn into a challenge for a market that seems to have a chip on its shoulder.

Read more from Wall Street Memes: CLOV Stock: The Next Big Short Squeeze?

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Take a guess: between now and end of year, which stock will have produced the most gains, GME or AMC?

(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content. Thanks for supporting Wall Street Memes)