S&P Dow Jones Indices will add Reddit to the S&P 500 before Tuesday's open, replacing AvalonBay Communities. Reddit shares jumped on the news, but Harvard research on prior additions shows the average bump from joining the index has faded to almost nothing since the 1990s.
Reddit shares jumped about 13% in Friday trading, near $179, after S&P Dow Jones Indices said Thursday evening it would replace AvalonBay Communities with Reddit in the S&P 500 before the market opens on Tuesday, Aug. 18. AvalonBay is leaving the index because Equity Residential is acquiring it. Even after the jump, Reddit sits roughly 37% below its 52-week high of $282.95.
Why the stock popped
Index funds tracking the S&P 500 must buy Reddit shares before Tuesday, and forced buying should push the price up, though it's an open question whether joining the index is worth 13% of a company's value. Research from Robin Greenwood and Marco Sammon of Harvard Business School, titled "The disappearing index effect," found the average abnormal return from an S&P 500 addition fell from 7.4% in the 1990s to less than 1% in the 2010s, a result the study calls statistically indistinguishable from zero. Getting dropped from the index has faded the same way: it cost the average deletion 16.1% in the 1990s and just 0.6% in the 2010s.
Reddit is joining directly from outside the S&P's smaller benchmarks, a group that has historically fared better. Direct additions returned 10.2% in the late 1990s, 8.8% in the 2000s, and 5.4% in the 2010s, though that last figure leans on Tesla's outsized 2020 inclusion rally; excluding Tesla, the study found 2020 additions averaged roughly nothing. The authors attribute the decline to more additions migrating up from indexes index funds already own, and to markets that have become better at supplying shares when funds need to buy.
The business behind the ticker
Reddit's revenue has grown more than 60% year over year for eight straight quarters, reaching $2.8 billion over the trailing 12 months, with about $871 million of net income over that span. But the stock sank two weeks ago after management told investors its search referral traffic had been choppy, since a large share of Reddit's traffic arrives through Google and Google's AI-generated answers increasingly make searchers less likely to click through.
At about 40 times earnings, Reddit trades at a price that assumes its growth continues. Daniel Sparks, writing for The Motley Fool, said the index announcement changes nothing about that traffic pipeline and that he would be cautious on the stock here.
Source: Fool
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