The media and business press often give a high level of attention to stocks and shares. And it has been newly promoted to one of the major indices. Such as the FTSE 100 or the S&P 500.
However, for every rising star promoted to such indices, there is also a relegation. Such shares may be relegated to a lower-ranking index. Such as the FTSE 250 or dumped from the major indices altogether.
Long Term Investment Strategy: Fund Managers and Institutional Investors
Once a stock or share has been relegated to a lower-ranking index or dropped from the major indices altogether. This can lead to a further fall in the price of a share.
While the actual value of the company may not have changed, many fund managers and institutional investors that are constrained to investing shares, which are in the top indices.
For the relegated share, this means that many fund managers and institutional investors will be forced to sell the shares. Regardless of the performance of the underlying company.
The result is a sudden increase in supply to the market, which is taken up by lowering the share price. For the long term investor, this can lead to the potential to buy a share at an artificially low price.
Long Term Investment Strategies: Why Relegated Share May be Undervalued
In considering why the relegated share represents a potentially profitable long term investment strategy. One must consider the objectives of the long term investor.
Here, one may consider that the long term investor is interested in the underlying value of a share rather than the share price on a given day.
As such, if the sole reason for the fall in a share price is simply because of an increase in supply due to fund managers and institutional investors dumping the share. Then, this does not represent a fall in value for the long term investor.
As long as the fundamental profitability of the company remains the same, then the share represents a bargain for the long term investor in comparison to previous prices.
This stated the long term investor needs to conduct further research. In some cases, the relegated share may have been dropped from a major index due to the poor performance of the underlying company.
In such a case, the share would represent a poor investment choice. In formulating a long term investment strategy based around relegated shares. The fundamental consideration to have the share been relegated due to poor performance or simply because the share needs to make way for a rising star.
Long Term Investment Strategies in Action: Corus and the FTSE 100
An example of such a strategy in action is illustrated by Simon Thompson of Investors Chronicle. In this example, three companies Corus, Hays, and Emap, all laggards of the FTSE 100 were relegated following the meeting of the FTSE International Committee Review.
However, following the relegation, Corus shares saw a rise of 50% while Hays and Emap shares outperformed the index, albeit by a smaller margin.
Long term investment strategies based on the analysis of relegated shares may provide one method of finding bargain shares for the investor.
However, extensive research should be conducted in order to decide if a share represents a true bargain or whether the share has been relegated for a good reason.