Beyond the Index Effect: What S&P 500 Inclusion Really Means for Stock Prices

Palantir joined the S&P 500 on September 23, but recent data indicates the S&P 500 effect isn’t what it used to be

• The "index effect" occurs when a stock gets a short-term price boost after it’s added to a major index like the S&P 500. It’s driven by increased demand from index funds and other passive investors.
• Studies show the index effect has become less pronounced since 2010, with the average stock exhibiting less volatile behavior both before and after its inclusion.
• Being included in the index reflects a company’s success but doesn’t guarantee growth. Strong fundamentals remain the key to long-term performance.

In early September, Palantir (PLTR) was trading steadily around $30 per share. But within just 10 trading days, the stock soared past $37, marking an impressive 23% surge.

The catalyst? Not a major earnings report or groundbreaking product release, but the simple announcement that Palantir would soon be joining the prestigious S&P 500.

This kind of rally—driven solely by news of being included in an index—raises an important question: Does joining the S&P 500 truly signal long-term growth, or is it merely a temporary boost fueled by short-term demand from index funds and passive investors?

To answer that we need to step back and analyze broader trends.

Big gains aren't exclusive to stocks in the S&P 500

The “index effect” refers to the market phenomenon where a stock’s price experiences a significant change—typically an upward spike—when it’s added to a major stock index like the S&P 500 or Nasdaq 100. This effect is driven, in part, by the buying pressure from index funds and exchange-traded funds (ETFs) that are required to purchase shares of newly added companies. That sudden increase in demand often drives prices higher.

A detailed analysis of the index effect by the Federal Reserve yielded some fascinating insights. One was that stocks added to major indices tend to display “extraordinary pre-event performance.” In this case, the “event” refers to the stock’s official inclusion, often called the "effective date.” or ED.

The study, which examined data from companies the 562 companies added to the S&P 500 between October 1989 and October 2009. On average, companies experienced a 56% increase in market capitalization during the two years leading up to their inclusion, after adjusting for broader market trends.

When the study says "adjusted," it means the increase in market capitalization was normalized to account for overall market fluctuations. This ensures the 56% figure reflects the individual company’s performance, separate from general market movements.

The study also indicated a similar rise in earnings per share (EPS), which increased by an average of 57% in the fiscal years before and after inclusion. This close alignment between rising EPS and market capitalization underscores how companies selected for the S&P 500 typically demonstrate sustained financial success and market visibility. Recent examples like Super Micro Computer (SMCI) and Palantir Technologies (PLTR) fit this pattern perfectly.

Supermicro, which was added to the S&P 500 in March 2023, saw meteoric growth before facing scrutiny from regulators over alleged accounting issues. Even with this pullback, the stock remains up over 2,000% in the last five years. Palantir, on a similar trajectory, has climbed 365% since its direct public offering, or DPO, in 2020.

However, the Fed’s study also revealed a critical finding: There is no permanent benefit from the index effect. While inclusion may spark a short-term surge in stock price because of increased demand from index funds, this effect is temporary. Over time, it fades.

The study also showed companies with similar financial trajectories that weren’t included in the S&P 500 showed comparable stock price changes. While S&P 500 inclusion generates initial excitement, it doesn’t result in a long-lasting boost to a company’s value.

These findings were echoed in a similar study conducted by S&P Global, which further supports the idea that the index effect is more of a short-term phenomenon rather than a lasting advantage for companies.

Why the index effect isn’t what it used to be

Similar to the Federal Reserve, S&P Global conducted an in-depth investigation into the index effect. As the owner and operator of the S&P 500 through its S&P Dow Jones Indices division, S&P Global is positioned to analyze the influence of index inclusion on stock performance.

One revealing aspect of the study was the examination of stock performance between the announcement date (AD)—when a company’s inclusion in the index is made public—and the effective date (ED)—when the stock is officially added to the index. 

To gain a clearer perspective, S&P Global measured excess return, which it defines as the difference between a stock’s total return and the overall return of the S&P 500. This approach, like the Federal Reserve’s, controls for broader market movements, providing a more accurate picture of a stock's specific response to its inclusion in the index.

The findings from this examination demonstrate that the index effect has become significantly less pronounced over time. From 1995 to 1999, the median excess return for stocks added to the S&P 500 was 8.32%. However, from 2000 to 2010, that figure dropped to 3.64%. By 2011 to 2021, the excess return had dwindled to almost nothing, a negative 0.04%.

The post-inclusion performance exhibited a similar pattern. Stocks were evaluated over a 21-day period following the effective date, and from 1995 to 1999, they recorded an average negative excess return of 4.50%. From 2000 to 2010, this negative effect narrowed to minus 1.69%, and from 2011 to 2021, it nearly disappeared, dropping to a negative 0.12%.

As illustrated above, the findings from S&P Global indicate the market's reaction to index inclusion has weakened considerably since 2010. Stocks that once saw large pre-inclusion gains and post-inclusion pullbacks now experience far less dramatic movements (on average). This trend reflects the shifting dynamics of passive investing, and the broader market’s reduced sensitivity to index-related events.

Strong fundamentals trump index inclusion

The data from multiple studies paints a clear picture: while the index effect remains, its power has become significantly less pronounced.

Consider Palantir and Erie Indemnity (ERIE), both added to the S&P 500 on Sept. 23, 2024. In the 10 trading days before inclusion, Palantir surged by 23%, while Erie saw a more modest 3% gain. Since officially joining the index, Palantir's stock has risen an additional 15%, whereas Erie has declined by 12%.

This stark contrast underscores the variability of the index effect: while some companies experience a clear spike in demand and visibility, others see little to no tangible benefit, as highlighted below. In fact, the broader data shows more companies tend to exhibit behavior similar to Erie’s modest gains or declines, instead of Palantir's standout performance.

The key takeaway is that a company’s long-term performance is driven far more by its underlying fundamentals than by the short-term effects of index inclusion. Companies like Palantir, with strong earnings growth and expanding market share, are already on an upward trajectory. Being added to a major index might accelerate their rise, but it isn’t the root cause of their success. Conversely, a company like Erie, with less momentum, may not reap the same benefits, even after joining the S&P 500.

This highlights a critical point: index inclusion is often a reflection of a company’s established success instead of the catalyst for it. Strong stocks tend to perform well based on their own merits, with the index effect serving as a short-term amplifier, not a long-term driver. For investors, that means the best strategy for sustained growth remains focusing on a company’s fundamentals—its earnings, growth potential and competitive advantages—instead of relying on the manufactured (and often temporary) boost that comes with index inclusion.

Andrew Prochnow has more than 15 years of experience trading the global financial markets, including 10 years as a professional options trader. Andrew is a frequent contributor of Luckbox Magazine.

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