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On December 9, 2011, the Nasdaq OMX Group announced the names of the companies that would be added and dropped from the Nasdaq 100 Index. This year there were five companies added and dropped.

The five companies added in 2011 were:

FOSL

Fossil, Inc.

AVGO

Avago Technologies Limited

NUAN

Nuance Communications, Inc.

HANS

Hansen Natural Corporation

GOLD

Randgold Resources Limited

The five companies dropped in 2011 were:

ILMN

Illumina, Inc.

QGEN

Qiagen N.V.

NIHD

NII Holdings, Inc.

URBN

Urban Outfitters, Inc.

FLIR

FLIR Systems, Inc.

From the following valuation metrics, the companies that are being added to the Nasdaq 100 appear more overvalued than those being dropped.

  • As a group, the stocks being added to the Nasdaq 100 Index have an average price-to-earnings ratio of 60x. The average price-to-earnings ratio of the stocks being dropped is 21x.
  • The average price-to-book ratio for the companies being added is 5.23x while the price-to-book ratio for the stocks being dropped is 2.40x.

  • On average, the stocks being added are approximately 50% above their 52-week low while the stocks being dropped are only 12% above their 52-week low.

The theory is that the companies being added to the index will significantly improve their earnings enough to justify their high price-to-earnings ratio. Combined with the expectation of higher earnings is a higher stock price. However, from our cursory review of the performance of the companies added and then dropped from the Nasdaq 100 Index in 2010, the inclusion into the index hasn’t immediately translated in an increase of the stock price.

In the table below we show the 1-year performance of the seven companies added and dropped from the Nasdaq 100 in 2010. This performance is based on the announcement of December 13, 2010 until the closing price of December 9, 2011.

Symbol

2010

2011

% change

AKAM

Akami (added)

50.68

28.11

-44.53%

CTRP

C-Trip (added)

44.53

23.2

-47.90%

DLTR

Dollar Tree (added)

55.85

82.55

47.81%

FFIV

F-5 Networks (added)

139.06

114.74

-17.49%

MU

Micron (added)

8.14

5.89

-27.64%

NFLX

Netflix (added)

183.8

70.89

-61.43%

WFMI

Whole Foods (added)

48.63

69.11

42.11%

Average

-15.58%

CTAS

Cintas (dropped)

27.36

30.43

11.22%

DISH

Dish Network (dropped)

16.95

25.83

52.39%

FWLT

Foster Wheeler (dropped)

33.51

19.36

-42.23%

HOLX

Hologix (dropped)

17.42

17.2

-1.26%

JBHT

J.B. Hunt (dropped)

39.49

44.74

13.29%

LOGI

Logitech (dropped)

19.88

8.36

-57.95%

PDCO

Patterson Companies (dropped)

29.23

29.34

0.38%

Average

-3.45%

NDX

Nasdaq 100

2207.45

2318.68

5.04%

DJI

Dow Jones Industrial Average

11428.56

12184.26

6.61%

GSPC

S&P 500 Index

1240.46

1255.19

1.19%

While not a rousing success for either group, the companies that were added to the Nasdaq 100 Index suffered three times the loss than occurred for the stocks that were dropped from the index. Of the stocks that were added to the index, the non-tech related companies, Dollar Tree (DLTR) and Whole Foods (WFM), outperformed with gains of 48% and 40%, respectively. This suggests that the “basics” will outperform in the coming year if the economy continues to experience stagflation. We believe that the recent re-introduction of Hansen Natural (HANS) will be among the top performing stocks at the time of the next re-ranking of the Nasdaq 100.

On November 18, 2011 (found here), we provided 13 companies that we believed were possible candidates for being removed from the Nasdaq 100 Index. We were able to identify three of the five companies that were dropped from the index. The characteristic that was most pronounced for the companies being dropped from the Nasdaq 100 Index was a market capitalization of $4 billion or less and 80% less average trading volume.

Because the Nasdaq 100 Index has outperformed most other indexes since inception, it appears that the success of the index has more to do with the companies that are able to remain on the index for a longer period of time rather than those that are added and dropped.

The Punchline:

  • Stocks added to the Nasdaq 100 in 2011 are overvalued
  • Stocks dropped from the Nasdaq 100 in 2011 are undervalued.
  • Stocks added in 2010 performed worse than stocks dropped in 2010.
  • Of companies added, Hansen Natural (HANS) is expected to perform above average.
  • Companies that are added or dropped from the index reduce the performance of the index.
  • Out of the 100 companies in the index, we correctly identified 60% of those that were dropped.
  • Companies on the Nasdaq 100 for an extended period of time may provide the basis for the index’s exceptional long-term performance.
Source: Nasdaq 100 Re-Rank Review