Playing the Adjustments to The S&P 500

We just learned that three former highflyers are being removed from the S&P 500 index to accommodate the addition of three spin-offs from Morgan Stanley (MS) and Tyco (TYC). These changes reminded me of an article I wrote back in 2005 about the contrarian way to play these types of index modifications.

What essentially happens is that poor performing stocks are the ones that get removed from the index, in favor of better performing ones, or as is the case now, spin-offs from member companies. Contrarian investors, not surprisingly, would take the view that the very fact that a stock is being removed from an index due to poor performance would be an excellent contrarian indicator.

The piece I wrote two years ago, Examining Changes to the Dow 30 Components, focused on the Dow because that index often is changed arbitrarily even when no stock get bought out and needs to be replaced. In the case of the recently announced changes, it is simply bigger firms replacing smaller ones. Still, the three beaten down tech stocks could very well represent contrarian long ideas. If you would like to take a closer look, the trio includes ADC Telecom (ADCT) at $19.14, PMC Sierra (PMCS) at $8.14, and Sanmina (SANM) trading at $3.41 per share.

Disclosure: Author has no position in above-mentioned companies.