There was plenty of excitement around the news that Palantir Technologies (NYSE: PLTR) would be added to the S&P 500 index. The index is widely viewed as the benchmark for U.S. stocks and there is an enormous amount of investor money tied to the index because so many exchange-traded funds (ETFs) and mutual funds track/mimic its performance.
Not surprisingly, when there is an announcement that a stock will be added to the S&P 500, it tends to see a nice jump in its share price. The reason is quite simple: S&P 500 index fund managers must now all buy the stock, which raises interest and helps push the stock price higher. Palantir stock, for instance, rose over 13% in the trading session after the news was announced. It will officially be added to the index on Sept. 23.
How does inclusion in the S&P 500 affect a stock?
According to a study conducted by S&P Global, stocks added to the S&P 500 between 1995 and 1999 outperformed the index by 8.3 percentage points between the announcement date and the effective date, while stocks added to the index between 2000 and 2010 saw an excess return of 3.6 percentage points during this period. This outperformance has been referred to as "the index effect." Likewise, removal from the index has been shown to have a negative effect on a stock's performance, although the performance effect of deletion also matters less these days than it used to.
The S&P 500 "index effect" has diminished over time
Median Excess Returns vs. S&P 500* | Sample Additions to Index | Sample Deletions from Index |
|---|---|---|
1995 to 1999 | +8.32 pps | -9.58 pps |
2000 to 2010 | +3.64 pps | -6.99 pps |
2011 to 2021 | +0.04 pps | +0.06 pps |
Source: S&P Dow Jones Indices LLC, FactSet. *The chart is based on the median excess returns of sample additions and sample deletions from the S&P 500 index between January 1995 and June 2021. The performance period is from the announcement date to the effective date. pps = percentage points.
However, the index effect has disappeared more recently. Between 2011 and 2021, stocks added to the S&P showed a decline of 0.04 percentage points between the announcement date and the effective date compared to the returns of the S&P 500. Meanwhile, stocks that were deleted from the index over this time outperformed the stocks that were added, generating a 0.06 percentage points excess return versus the index.
Meanwhile, after a stock is officially added to the S&P, it tends to underperform over the first 21 trading days it is in the index. From 1995 until 2021, new S&P additions underperformed by nearly 1.7 percentage points. Similar to how the index effect has waned, so has the underperformance of stocks immediately following their inclusion into the S&P. This can be seen with stocks added to the index having a slight negative comparative return of 0.12 percentage points between 2011 and 2021.
Median returns of sample S&P 500 additions 21 days after effective date
Study Period | Stock's Median Return Compared to S&P 500 |
|---|---|
Entire period | -1.69 pps |
1995 to 1999 | -4.49 pps |
2000 to 2010 | -1.69 pps |
2011 to 2021 | -0.12 pps |
Source: S&P Dow Jones Indices LLC, FactSet. Note: The chart is based on the median returns of sample additions from the S&P 500 index between January 1995 and June 2021. The performance is based on stock price 21 days after the effective date. pps = percentage points.
One caveat with Palantir is that stocks that were not in any prior S&P indexes (like the S&P MidCap 400 or the S&P SmallCap 600) did nicely outperform between their announced date and effective date. For the entire period S&P looked at, these stocks had excess returns of 6.2 percentage points, while they outperformed by 4.3 percentage points between 2011 to 2021. The group, however, still underperformed the index 21 days after being added by nearly 2.5 percentage points over the entire studied period and by 0.75 percentage points from 2011 to 2021.
Given the strong first-day gains from Palantir following the announcement of its inclusion in the S&P 500, history tells us that the stock will likely underperform over the next couple of months. However, there are certainly instances of very popular stocks continuing to skyrocket higher immediately after the announcement. For example, Tesla saw its stock soar about 70% back in 2020 after it was announced it was entering the S&P.
Joining the S&P 500 does not guarantee a stock will perform well over the long term, or even in the short term. For example, Super Micro Computer stock has crashed since being added to the S&P 500 index earlier this year.
Longer-term prospects
How well Palantir's stock performs over the next few years will likely depend far less on its inclusion in the S&P 500 and far more on whether the company can accelerate its revenue growth. The main reason behind this is its valuation, with the stock trading at a forward price-to-sales ratio of more than 23 times analyst estimates for 2025. For a company that grew its revenue by 27% in Q2, that's an incredibly high valuation.
Thus the key for Palantir will be to continue to accelerate its revenue growth from here. The company has done a very nice job growing its U.S. commercial revenue led by its artificial intelligence (AI) solutions. Meanwhile, its U.S. government revenue has been improving, although it needs to grow faster to help justify the company's current valuation. In order to help with that regard, it has entered into a partnership with Microsoft to offer its solution using Microsoft's various government cloud services.
That said, while Palantir is a great company, the stock's valuation is a bit too frothy at the moment to make for a good buy. As such, I would let the S&P inclusion hype dissipate before considering buying the stock.
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Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Microsoft, Palantir Technologies, S&P Global, and Tesla. The Motley Fool recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.
History Says Being Added to S&P 500 Will Have This Impact on Palantir Stock was originally published by The Motley Fool