Foreign media reports indicate that when a company is added to the S&P 500, the first change is typically not in revenue, profits, or production capacity, but in the amount of capital in the market that is required to hold the stock. For ETFs, mutual funds, and institutional accounts that track the index, component adjustments mean they must simultaneously rebalance their portfolios.
Passive foundation mechanical buying
The S&P 500 is maintained by S&P Dow Jones Indices and covers the U.S. large-cap stock market. To be included, companies typically must meet criteria such as market capitalization, liquidity, float proportion, and profitability; however, meeting these thresholds does not guarantee inclusion, as the final decision rests with the index provider according to its established methodology.
The article states that the goal of an index fund is not to judge whether a stock is expensive or cheap, but to replicate the index as closely as possible. Therefore, once a new constituent stock is officially added, funds tracking the S&P 500 must purchase it according to its weight.
For example, using free-float market capitalization weighting, if a newly added stock has a weight of 0.5% in the index, a $100 billion fund that fully replicates the S&P 500 would theoretically need to allocate approximately $500 million to that stock. When such demand is aggregated across ETFs, pension funds, and institutional portfolios, it creates concentrated buying pressure.
Inclusion does not guarantee sustained price increases.
The article mentions that the market has often referred to this phenomenon as the "index effect," where related stocks tend to strengthen between the announcement of inclusion and its official implementation, as some investors position themselves ahead of time, anticipating passive funds to follow.
However, research by S&P Dow Jones Indices shows that this effect has significantly weakened between 1995 and 2021. As market liquidity improved and anticipated trading became more efficient, investors absorbed information about component changes earlier, reducing the upward price pressure that index inclusion once had.
This also means that inclusion in the S&P 500 can generate additional demand, but it does not guarantee sustained long-term price appreciation. After the event, stock performance will revert to fundamental factors such as earnings, valuation, economic conditions, and market expectations.
Long-term valuation may not necessarily increase as a result.
The article also cites research from the New York Fed, noting that companies entering the S&P 500 often experience earnings growth, increased market capitalization, and stronger stock prices prior to inclusion. In other words, many companies become larger and perform better before joining the S&P 500, rather than becoming more valuable because of their inclusion in the index.
Research, after excluding pre-inclusion strong performance, finds that simply becoming a S&P 500 constituent does not automatically lead to a permanent valuation increase.
Therefore, the inclusion in the S&P 500 is more like a shift in holding structure—it changes who must buy the stock and affects supply and demand in the short term, but does not directly alter the company’s operational reality.