Will Facebook (Nasdaq: FB) Stock Feel "S&P Effect"?

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Facebook (Nasdaq: FB) stock still has a lot to prove if it wants to win over value investors, but it took a big step in that direction Wednesday with the announcement of its addition to both the S&P 500 and S&P 100 Indexes.

The social networking giant will replace Teradyne Inc. (NYSE: TER), a manufacturer of test computer chips, in the prestigious broad-based S&P 500, and will change places with natural gas company Williams Cos. Inc. (NYSE: WMB) in the more elite S&P 100 at the close of business on Dec. 20.

The S&P 100 Index, a subset of the S&P 500, is a compilation of 100 leading U.S. stocks with exchange-listed options. Components represent roughly 57% of the market cap of the S&P 500, and almost 45% of the market cap of the U.S. equity markets. S&P 100 constituents tend to be the largest and most established companies in the S&P 500 and historically have a lower turnover rate than that of the S&P 500.

Following the announcement, Facebook stock soared 4.1% in afterhours trading, with 5.4 million shares changing hands. Thursday FB stock rose about 5%. More than 82 million shares were bought and sold, surpassing FB's average monthly volume of 74 million.

The world's social networking leader will be added to the Internet software and services sub-industry of the S&P 500, joining established peers Google Inc. (Nasdaq: GOOG), eBay Inc. (Nasdaq: EBAY), Yahoo! Inc. (Nasdaq: YHOO), and Amazon.com Inc.(Nasdaq: AMZN).

Facebook also takes a bow for being the first among social Internet companies that launched IPOs over the last three years to make it into the S&P 500 Index. Those include LinkedIn Corp (NYSE: LNKD), Yelp Inc. (NYSE: YELP), and Twitter Inc. (NYSE: TWTR).

How a Stock Gets Added to S&P Indexes

S&P components are selected by a committee using eight primary criteria: market capitalization, liquidity, domicile (address), public float, sector classification, financial viability, length of time publicly traded, and listing exchange. A member must have a market cap equal to or greater than $4 billion and a minimum monthly trading volume over the last six months of 250,000.

Facebook's average monthly trading volume is nearly 74 million and its market cap has more than doubled year to date to $124 billion. That dwarfs the $3.2 billion market cap and 30-day average trading volume of 1.7 million shares of Teradyne. Teradyne - which moves to the S&P MidCAp 400 - has watched its numbers barely move since January.

Some 19 months after its IPO, Facebook is already a Russell 1000 Index member and included in the MSCI World Index. In December 2012, it joined the Nasdaq 100 Index after the over-the-counter exchange operator cut its usual two-year waiting (seasoning) period as part of IPO negotiations that led Facebook to choose the Nasdaq over rival NYSE for listing.

What does all this mean for Facebook stock investors?

Facebook (FB) Stock: Is There an S&P 500 Effect?

The addition to the indexes is a vote of confidence in the Menlo Park, Calif.-based company. It also follows four consecutive profitable quarters, another condition the S&P uses to determine eligibility for joining the index.

After Facebook went public in May 2012 at $38 a share, in an initial public offering that was marred with technical and trading glitches, shares lost more than half their value over the next four months. This year, FB stock has rallied some 86%.

Adding Facebook to the indexes will create additional demand for shares and an initial pop in price. Gaining entry to the benchmarks gives Facebook an assured shareholder base from the funds that track the indexes. According to S&P's website, more than $5.14 trillion funds follow the S&P 500 index alone.

However, studies show that being added to the S&P 500 - the "S&P effect" - does not guarantee any permanent price increase. This was studied in the frequently referred to 2001 report, "The S&P 500 Effect: Not Such Good News in the Long Run," by Daniel Cooper, a member of the Board of Governors of the Federal Reserve System, and Geoffrey Woglom of Amherst College. What they found was it leads to a permanent increase in a stock's price volatility that grows over time.

Separately, USA Today found the initial share price spike averages 5% after an S&P index addition. FB's gain Thursday very closely mirrored that.

Sometimes, though, the initial pop is reduced because mutual funds can buy small amounts of stock over time after a company is added to the index.

Additionally, sometimes funds already own the stock if it's in another index (as is the case with Facebook) or they were anticipating an addition to an index. Facebook had been rumored to be added to the S&P for months. Also, if a company's stock price has already been bid up (like Facebook's) because of that anticipation, it typically doesn't gain much after it's added to the index.

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