S&P 500: Decision (or not) Time

The Method

During quarterly reviews, S&P 1500 index rebalance is mainly fueled by Index Committee discretionary decisions of newly eligible companies entering the index and replacing the lowest market capitalization existing constituents. This is in contrast with intra-quarter transitions which are usually triggered by a corporate action.

Seemingly, the selection process at quarterly reviews has a more unpredictable and discretionary nature even more so in the lower segments – Mid Cap and Small Cap – compared to S&P 500 due to the larger number of smaller companies. Therefore in this report the focus will be on S&P 500 eligibility due to larger impact and narrower pool of candidates. Any potential additions would be backed by patterns observed in previous reviews.

To be eligible for entry in S&P 1500 hence for S&P 500, the main criteria to pass include:

  • Profitability: profitable over the last four quarters and in the most recent quarter.
  • Liquidity: annual dollar volume traded must be at least 75% of the company’s float market capitalization and a minimum of 250,000 shares must trade in the six months leading up to the evaluation date.
  • Size: pass market and float capitalization thresholds. Distances to threshold mentioned below refer to how much above or below a company’s market capitalization is compared to the minimum required to enter S&P 500.  


The Past

In December 2022 newly eligible companies for S&P 500 were Horizon Therapeutics (HZNP) Texas Pacific Land Corporation (TPL) and HEICO (HEI) with distance above the threshold ranging from 36% to 24%. However, S&P chose neither newly eligible nor existing constituents to be added to S&P 500. Top constituents of S&P Mid Cap 400 were at the time 20% above threshold.

In the March 2023 review, a lot of companies became newly eligible for S&P 500. Leading the board in terms of market capitalization was Palo Alto Networks (PANW), Cheniere Energy (LNG), and Ferguson (FERG) with outstanding distances above the threshold ranging from 77% to 57%. Previous newly eligible companies in December 2022 (HZNP, TPL, HEI) were still eligible for March 2023 with distances from 50% to 10%. Nonetheless, S&P chose an existing constituent of S&P Mid Cap 400, Fair Isaac & Co (FICO) to enter the segment with 25% distance over threshold.

In the June 2023 review, we see PANW entering S&P 500 after being eligible for two consecutive quarters – March 2023 and June 2023 – with an outstanding distance of 80% above threshold. Previously in December 2022 review, PANW was failing profitability criteria. Top constituents of S&P Mid Cap were found at 18% above threshold but were not chosen to enter S&P 500.

Interesting to note are companies in ‘shadow’, meaning they have been eligible for the last 2 years with huge market capitalizations but are not chosen to enter S&P 500 and S&P 1500 overall. Few of the biggest companies in this list include Airbnb, Lululemon and VMware. Since they have been neglected then it is assumed that their probability of addition in the near-future is negligible without some sort of trigger.


The Future


Existing constituents: Low conviction

Hubbell Incorporated (HUBB) and Builders FirstSource (BLDR) are the main top companies in Mid Cap most likely to enter S&P 500 out of the current members of S&P 1500. However, we are placing a very low conviction on these additions due to their potentially inadequate distance above threshold which is only around 17%. Based on previous reviews for an existing constituent such as FICO to enter, a minimum of 25% distance above threshold is needed.

Non-constituents: Low-Medium Conviction

Main candidates to enter from out of the index to S&P 500 are Cheniere Energy (LNG), The Trade Desk (TTD) and Ferguson (FERG). They became eligible for the first time in March 2023 together with PANW which was added in June 2023 with a distance of 80% over threshold. The three candidates have a distance ranging from 63% to 55% with LNG leading. However 63% can still be considered inadequate by the Committee for an addition to the index compared to 80% of PANW or the candidates can be added to shadow. However, the distances are noticeably above the threshold and the candidates are relatively newly eligible. We also observe around 1 addition to S&P 500 each quarter on average.


Deletions will be a consequence of an addition to the segment to keep the fixed number of constituents. Likely candidates are the lowest market capitalization constituents of S&P 500 which are currently DXC Technology (DXC), Newell Brands (NWL), Lincoln National Corporation (LNC). These companies in the scenario of exiting S&P 500, will migrate all the way to S&P Small Cap 600 due to their low market capitalizations which qualify only for that segment. The most likely exit candidate would be DXC as it is found stunningly at 240% below S&P 500 market cap threshold followed by NWL and LNC with distances of  235% and 230% respectively. DXC’s GICS sector of Information Technology is also slightly overweight in S&P 500 which enhances its probability of exit. In the event of an addition to S&P 500 then the deletion for one of these 3 companies has a high conviction.


The Conclusion

For the September 2023 review, potential additions are likely to be coming from non-constituents rather than current constituents. Cheniere Energy is the main candidate for addition followed by Trade Desk and Ferguson. There is always the chance that these newly eligible companies stay in shadow or get added at a subsequent review. The added company is expected to experience $6 billion in passive demand equivalent over 12 days of volume.

Deletions are conditional to the additions. In the scenario of an S&P 500 addition, the main candidate for exit is DXC Technology followed by Newell Brands and Lincoln National Corporation. The deleted company is expected to experience $245 million in passive supply equivalent to 5 days of volume.

Any passive fund flows will take place at close on Friday, 15 September 2023. 

A scenario of no transitions for S&P 500 is also possible as observed in previous reviews.