Stocks that get added to the S&P 500 typically see a strong rally as funds quickly buy up shares, and with turnover on the index expected to increase in the coming weeks, one analyst is offering up some attractive prospects. When a company is added to the S&P 500, shares usually trade higher on heavier volume. That's because funds like the Vanguard 500, which are designed to track the performance of the S&P 500, are required to invest in all stocks that make up the index. Funds typically use the replication method of indexing, meaning that they attempt to hold the same stocks as the index and in approximately the same proportions. For instance, Iron Mountain ( IRM) shares rallied 13% on Dec. 30 after it was announced the company would be added to the S&P 500. By the time it was officially added to the index on Jan. 5, the stock had jumped 25%. Wynn Resorts ( WYNN) jumped 7% a day after the S&P 500 said it would add it to the index. In the week between the announcement it would join the index and its actual addition, Mastercard ( MA) shares jumped 13% to $285.47. Even more recently, Northeast Utilities ( NU) was announced Thursday as the newest member of the index, replacing Tyco ( TYC). Shares of Northeast rose on the news. Melissa Roberts, analyst with Keefe, Bruyette & Woods, said that while turnover on the S&P 500 remained low in February, she believes it will pick up in March, giving investors a chance to net a quick profit. Through the first two months of 2009, only three constituents were swapped out of the S&P 500. By comparison, seven constituent changes were made in December alone.
Four changes have already been announced and were made effective on March 3. American Capital ( ACAS) and Jones Apparel ( JNY) were stripped from the S&P 500 due to dwindling market capitalization, and Hormel Foods ( HRL) and Ventas ( VTR) were added to the index. While the M&A pipeline has been at a standstill due to weak credit markets, there are four pending deals that involve S&P 500 members as acquisition targets, including Rohm & Haas ( ROH), Wyeth ( WYE), Embarq ( EQ) and CF Industries ( CF). Those potential deals open the door to new index additions in the near future. Roberts has a list of four companies that "meet S&P Index requirements and may be on the index committee's radar screen as potential index additions." Roberts makes one of the best cases for Visa's ( V) inclusion on the S&P 500, saying it has been a year since its IPO, making it eligible for addition according to the index's seasoning requirement for IPOs of nine to 12 months. "If Visa were to be added to the S&P 500 Index, based on pricing and volume data as of March 2, we estimate that S&P 500 Index Funds would have to purchase about 26 million shares of Visa, implying about 3 days of buying volume," Roberts wrote in a research note. Roberts' top pick within the banking industry group is New York Community Bancorp ( NYB), as the company has a $3.2 billion market cap and ranks as fourth-largest eligible financial addition and 26th largest eligible addition to the S&P 500, Roberts said.
New York Community Bancorp is also attractive as the S&P 500 may start adding financial companies more aggressively than it has in the last few months. Peoples United Financial ( PBCT) was added to the index in November, making it the first banking institution admitted since Hudson City Bancorp ( HCBK) in February 2007. Meanwhile, about a dozen financial names were purged from the index for various reasons, including Freddie Mac ( FRE), Fannie Mae ( FNM), Lehman Brothers, Bear Stearns and Washington Mutual. Roberts notes that the recent removal of Sovereign Bancorp, acquired by Banco Santander ( STD) in January, without a banking replacement in the index, may increase the odds of an addition from the banking industry. "However, given the underperformance of banking stocks relative to both their financial and non-financial peers, S&P may be cautious about adding a banking member in the near term," Roberts wrote. Roberts also says that Everest Re Group ( RE) and Fidelity National Financial ( FNF), both S&P 400 constituents, are likely to be added in order to better represent insurance names. Several insurance constituents were removed but not replaced in the index in 2008, including Safeco and ACE Ltd. ( ACE) And despite the fact that the S&P 500 seeks to keep turnover at a minimum and does not actively seek to remove names from the index, Roberts says that several stocks that rank low on the list could face the boot, meaning that index funds could sell shares. "In the S&P 500 Index, four financials rank within the bottom ten companies in the index," Roberts wrote, referring to Developers Diversified Realty ( DDR), E*Trade Financial ( ETFC), Huntington Bancshares ( HBAN) and MBIA ( MBI). Roberts asserts that those four names "are at the greatest risk of near-term deletion from the Index if the Index Committee decides to proactively remove the next smallest ranking constituents."