After the latest round of Sensex stocks rejig was announced in mid-November-2021, outgoing stock Bajaj Auto cracked nearly 13 per cent in a month while incoming tech giant Wipro shares gained 2.4 per cent in the same period amid a weak overall market. This example fits well with the popular narrative that exiting Sensex constituents are de-rated and entrants are celeb-rated.

An analysis of over three dozen index stock inclusions and exclusions since 2013 shows that three-fourths of the stocks in the inclusion list did gain over a one-month period following the announcement. At the same time, 60 per cent of the stocks in the exclusion list too moved up in the one month period following the announcement.

Net-net, the study shows that overall market mood and fundamental factors ultimately make a difference to the stock performance and tactically entering inclusion stocks and exiting excluded ones is not a surefire way to success in investing.

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Entry and exit bring gains

We looked at the 1-month and 3-month performances of 20 Sensex stock inclusions from November-2013 to December-2021 to find if you should buy Sensex entrants on inclusion announcement. There is a fair chance that you can pocket nifty gains in the short-term if you buy a Sensex entrant on the official news. Data shows 75 per cent (or 15 of 20) of the Sensex entrants gained in the one month period from the day the announcement is made by Asia Index Pvt. Ltd., the housekeeper of the indices. The average 1-month gain of Sensex inclusion stocks is 5.1 per cent. The biggest money was made in buying Bajaj Finserv that gained 43 per cent in a month after the inclusion announcement in May-2020. The next best 1-month gains were in Axis Bank in Nov-2013 (up 19 per cent) and Dr Reddy's in Nov-2020 (up 8.5 per cent).

If you held on for slightly longer periods, say 3 months post the inclusion announcement, there is no change in money-making chances. Similar to the 1-month period, 74 per cent of Sensex entrant stocks gained in 3 months.

What is counter-intuitive is that there is a good chance that you can pocket gains even if you buy a Sensex stock when the announcement comes that it is being left out of the benchmark. As many as 60 per cent of such stocks gained in the 1-month period following the announcement, with some such as Dr Reddy's rising over 20 per cent and Hero MotoCorp and Tata Steel seeing 12 per cent uptick each. Tata Motors (2019) and ONGC (2021) gained 7-8 per cent in a month of their respective exit announcements.

Mood, fundamentals matter

When a stock appears under the Sensex inclusion list, there is obviously buying interest from index funds and ETFs, apart from traders looking to make a quick buck. But, most superlative performances have happened when the market was buoyant. Entrant Bajaj Finserv rallied over 40 per cent in a month when the Sensex galloped nearly 14 per cent after falling due to the infamous Covid-induced slump. Axis Bank shares spurted when the index gained over 4 per cent in a month. Ditto for Dr Reddy's. When the overall market has fallen sharply, the 1-month gains of Sensex entrants such as Wipro (up only 2.4 per cent) are quite muted.

About one in four stocks exiting the Sensex notched up gains even 3 months from the time of announcement. Notable examples of this trend are Hero MotoCorp (up 40 per cent) and Tata Steel (up 28 per cent) in 2020. In both cases, markets were very strong in those periods on recovery hopes, which helped build the bullishness. In 2016, BHEL also marked a 20 per cent gain in 3 months from the day its exit was announced from Sensex, riding high on the nearly 11 per cent gain in Sensex itself.

Fundamental factors take over though, beyond the euphoria. Stocks such as Adani Ports (down 23.7 per cent since inclusion in Nov -2015) and Vedanta (down 18 per cent since inclusion in May 2018) lost big when held for 3 months from their respective inclusion announcement. In the case of Vedanta, for instance, closure of Sterlite’s copper plant in Thoothukudi dampened the mood.

And, 74 per cent of the exclusions fell in the 3 months following. Since Sensex is constructed based on float-adjusted market capitalisation, any sustained sharp fall in stocks may lead to an exit and hence the trend could continue post-exit too. This typically happens due to company-specific factors. For instance, Yes Bank lost over 23 per cent after official news of being out of the bellwether in November 2019. But the private sector lender was already in trouble since April that year and the stock had tanked from ₹270 to ₹70 levels when the Sensex index committee bid it adieu.

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