The Economic Times daily newspaper is available online now.

    How the entry or exit from Nifty impacted individual stocks

    Synopsis

    Inclusion of a stock in a diversified market benchmark like Nifty 50 is often considered to be a positive. Similarly, exclusion from the index is often interpreted as a signal to get out as returns are perceived to be sub-optimal. But, does this theory play out in the real world?

    Stock-marketGetty Images
    Inclusion or exclusion from an index doesn’t necessarily reflect a stock’s ability to generate returns.
    Inclusion of a stock in a diversified market benchmark like Nifty 50 is often considered to be a positive. Similarly, exclusion from the index is often interpreted as a signal to get out as returns are perceived to be sub-optimal. But, does this theory play out in the real world? Not quite. A study of long-term returns pertaining to 48 stocks of which 25 have entered and 23 have exited Nifty 50 since 2015 throws up unique insights. Findings suggest that a large part of value creation in the stocks happens prior to inclusion, whereas a large part of value destruction happens prior to exclusion.

    The Nifty 50 index is computed using a free-float market capitalisation (m-cap) method. The constituents of Nifty 100 trading on NSE’s Futures & Options segment are eligible for inclusion. The company’s trading frequency should be 100% in the last six months for inclusion. The security should have traded at an average impact cost of 0.50 % or less during the last six months for 90% of the observations for a portfolio of Rs.10 crore. Companies are eligible for inclusion if the average free-float m-cap is at least 1.5 times the average free-float m-cap of the smallest constituent of Nifty 50. The semi-annual review of Nifty 50 is based on data for six months ending January and July. The replacement of stocks (if any) is implemented from the last trading day of March and September. A 4-week notice is given in case of any replacement. A maximum of 5 companies (10% of the index) may be added in a calendar year.

    Here are a few charts that tell you the story, along with some key takeaways.
    im-1

    Key takeaways

    • While inclusion in a popular index such as Nifty 50 does help the standing of a stock, valuation re-rating may occur over the long term on account of financial performance, positive market sentiment, successful strategic initiatives, and favourable industry trends.
    • Valuations may decline due to poor financial results, negative market sentiment, expectations of slower earnings growth, operational challenges, regulatory issues, or broader economic downturns/cycles.

    im-2

    Key takeaways

    • Once removed from the index, the companies may face reduced scrutiny, allowing them to focus on fundamental improvements and strategic initiatives. This may lead to enhanced performance and investor confidence, resulting in better returns after exclusion.
    • Exiting the index may prompt a reassessment of the company¡¦s value proposition, potentially attracting new investors and driving up stock prices.

    (Catch all the Personal Finance News, Breaking News, Budget 2024 Events and Latest News Updates on The Economic Times.)

    Subscribe to The Economic Times Prime and read the ET ePaper online.

    ...more
    The Economic Times

    Stories you might be interested in