What Happens When A Stock Is Added To The S&P 500?

There was a flurry of excitement when it was announced that drug developer Moderna (MRNA) would be added to the roster of Standard and Poor’s top 500 stock picks, with many pundits seeing its inclusion on the prestigious index as a mark of recognition for its work fighting the coronavirus pandemic, and a vindication of the technology it had been perfecting over the course of the last decade.

But how is a company inaugurated into this elite club? And once in, can it ever leave?

What Is The Benefit Of Being Added To S&P 500?

Perhaps the most important question for a business and its investors is precisely this: what good is being on the S&P 500, anyway? You might think that getting listed on the S&P 500 is like playing in the top division of your sport – but the analogy isn’t always that clear.

In fact, there are some well-known drawbacks to being included in the S&P 500, and research has shown that the price impact of inclusion to a stock is often negative.

One consequence of inclusion in the S&P 500 is that passive tracker funds are now essentially compelled to buy the stock. This can have both good and bad outcomes for a company.

On the positive side, a firm may see its share price rise as a slew of new investors grapple to purchase its stock; however, a negative effect of this is that the business then becomes owned by people who don’t share the company’s ethos, and can lead to bad corporate governance and decision-making further down the line.

In Moderna’s case – a company with a tightly knit outfit featuring strong management and a unique vision – loss of control over the project’s direction can often end in catastrophe.

Other less desirable factors that S&P 500 companies have to deal with is the increased scrutiny of their businesses and closer attention from credit agencies. These aren’t always bad things, but just add another layer of complexity that some companies aren’t accustomed to up until S&P 500 inclusion.

So, what are the benefits of belonging to the S&P 500 other than just simple prestige and an initial bump in stock price? The truth is, not an awful lot – although easier access to cheaper debt and some alternative capital markets can be a welcome plus.

But as Moderna shareholders found out last week, that one-time price jump can be pretty significant. Moderna stock was up nearly 20% after being listed on the S&P 500, bringing its one-year price rise to more than 360% in total.

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How Does A Stock Get Added To S&P 500?

As the name implies, Standard and Poor’s touchstone index is capped at a maximum 500 companies, meaning that as one company is added, another one has to say goodbye. And for Moderna to gain entry this time round, the S&P 500 had to let go of Alexion Pharmaceuticals (ALXN).

In this particular case, Alexion was due to be acquired by AstraZeneca (AZN), and so a space for Moderna opened up quite naturally.

There are some well-defined rules for entry into the S&P 500, and a prospective company has to meet all of them to then have the final decision made by a special committee before finally getting the nod.

The first hurdle to clear is the market cap test: is a company big enough to merit inclusion on the list? Obviously, the bar for this metric rises over the years as inflation works its magic, but the current minimum worth of a company stands at $11.8 billion.

Once this filter has been successfully passed, other criteria need to be met. The next important consideration is whether a company is profitable or not. There’s a little leeway here, and a company can show it is making money either as an average of its last four quarters, or in just the most recent quarter alone.

Assuming market cap and profitability are all in order, a firm must then show that its shares are majority owned by the public, that they can be purchased on a publicly traded index, and that its shares are liquid and sold in meaningful volumes. Also, the company must operate in the US and file a 10-K annual report.

If all these tests are met – and barring a few exceptions relating to certain exchange-traded funds, closed-end funds and “exotic” company arrangements – then the decision to admit goes to U.S. Index Committee for final confirmation. The Committee seeks for the S&P 500 to represent companies that are industry leaders, and will include well-known brand names and also lesser-known firms if they meet the eligibility criteria.

What Does It Mean That Moderna Joined S&P 500?

Moderna’s price rise will be welcomed by the company and investors alike, but the long-term fortunes of the business will rest on its continuing innovation and ongoing success of its COVID-19 vaccine.

The firm has plenty of other promising drugs in its pipeline, one among them being its Personalized Cancer Vaccine (PCV), mRNA-4157, which is already in phase II clinical trials.

It’s also important that Moderna doesn’t rest on its laurels. Its only commercial products are its coronavirus-related offerings, and it remains to be seen whether these will continue to be effective as the pathogen mutates and new variants develop.

But the company’s stock has been trending upwards since early 2020 – and there’s no real reason to think there are any immediate catalysts that will stop that progress anytime soon.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.