Comparing newly added stocks to removed stocks on the NDX
The Nasdaq 100 Index (NDX) is made up of the largest non-financial companies in the market. They recently carried out their annual rebalancing, adding six companies and removing six. The tables below show the six additions and removals, along with their 2020 return, and analyst “buy” percentages from Zacks. I decided it would be interesting to compare the returns going forward, of the stocks added as well as those removed.
Unpacking Additions vs. Removals
Since 2010, we tracked 60 stocks added to the Nasdaq 100, and the 54 removed (though we don’t have data on some of the removed stocks that aren’t trading anymore). For this study, I am only considering the stocks added and removed in December during the annual rebalancing, and not those eliminated and added mid-year due to bankruptcy, mergers, etc.
My theory in these situations is that the stocks removed will tend to outperform those added. There are two main reasons for this. First, the announcement of stocks being added will create buying pressure for those stocks by funds that replicate the index. The buying frenzy will push the stock price above fair value, causing underperformance going forward, and vice versa for those removed. Also, new stocks tend to be those that have performed well and have some hype behind them. It’s an indication of bullish sentiment, which has bearish implications based on our contrarian philosophy.
The tables below summarize the returns of the added and removed stocks over the next year. I would say it’s inconclusive whether my hypothesis above is correct. In the shorter term, the stocks removed performed slightly better than those added. For instance, three months after rebalancing, the stocks removed averaged a gain of 8%, compared to 6% for those added. Also, 52% of the stocks removed beat the NDX in that time frame, versus 48% of those added. Looking out longer term to six months and a year, the average returns were very similar, while the stocks removed had a slightly higher chance of beating the index.
The table below shows a year-by-year breakdown of the stocks that were added and removed. Perhaps investors have wised up to this tendency, therefore eliminating the edge? From 2010 to 2015, the stocks removed outperformed those added in five of the six years. Since then, the new additions were better in three of the four years. The last two years, it has not even been close. The new additions have done much better than the stocks taken out of the index. If you expect we revert to the old tendency, then you would be bullish on the stocks taken out of the index. If you think the last couple of years signifies a new development, then you would consider buying the newly added stocks.
