Unlocking Hidden Value: Why ‘Index Rejects’ Could Be Your Next Smart Investment Move

Index Rejects: The Overlooked Investment Opportunity

In a surprising twist for investors, stocks removed from major indexes like the S&P 500 may offer unexpected potential, according to investment expert Rob Arnott. The founder of Research Affiliates has identified a unique opportunity in these “index rejects,” challenging the conventional wisdom that delisted stocks are poor investments.

Stocks can be removed from indexes for various reasons, including insufficient market capitalization, bankruptcy, or regulatory noncompliance. However, Arnott’s research suggests that these factors don’t always reflect a stock’s true investment potential.

Research Affiliates’ findings reveal a counterintuitive trend: while index deletions typically underperform before removal, they often outpace the S&P 500 significantly in the subsequent five years. This pattern has caught the attention of savvy investors looking for undervalued opportunities.

Investing in index deletions presents a cost-effective way to gain exposure to small and mid-cap value stocks. These delisted companies are often priced at half the market multiple, offering substantial potential for price appreciation. The rapid sell-off by index fund managers following a stock’s removal further depresses prices, creating attractive buying opportunities for discerning investors.

This strategy may prove particularly beneficial in the current growth-dominated market. As Arnott suggests, it offers potential upside when the current market bubble eventually deflates.

However, experts caution that not all index deletions are sound investments. Careful selection is crucial to avoid “falling knives” – stocks that continue to decline after being delisted. Research Affiliates employs a rigorous screening process for deletions, aiming to construct a portfolio that outperforms the S&P 500 over a five-year horizon.

For investors interested in exploring this strategy, several recently delisted stocks have caught the attention of market watchers. These include Lumen Technologies (LUMN), Rivian (RIVN), Hawaiian Electric Industries (HE), Cirrus Logic Inc (CRUS), Herbalife Nutrition (HLF), Foot Locker (FL), and Lucid (LCID).

As the investment landscape continues to evolve, the potential of “index rejects” serves as a reminder that opportunities can be found in unexpected places. While this approach requires careful analysis and risk management, it offers an intriguing avenue for investors seeking value in today’s complex market environment.