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S&P 500 (.INX) Gives General Motors Company (GM)’s Stock a Boost

GM headquarters in Detroit. Photo credit: General Motors Company (NYSE:GM).

Four years after being kicked out of the S&P 500 IndexGeneral Motors Company (NYSE:GM) is set to rejoin the benchmark U.S. stock index later this week. S&P Dow Jones Industrial Average (INDEXDJX:.DJI) said late Monday that America’s largest automaker would join the S&P 500 (INDEXSP:.INX) and S&P 100 indices after the market’s close on Thursday. General Motors Company (NYSE:GM)’s stock was up about 2% in early trading on Tuesday.

GM will replace H.J. Heinz Company (NYSE:HNZ), which is being taken private in a transaction expected to close by the end of this week. It’ll rank 79th in the index in terms of market cap, according to Bloomberg.

Rejoining the principal U.S. stock index is a point of pride for GM’s current management, and a milestone in the big automaker’s recovery from its 2009 bankruptcy. But it’s also a good thing for General Motors Company (NYSE:GM) shareholders. Let’s take a closer look at why.

General Motors Company (NYSE:GM)

Joining a major index is a big deal
When a company joins a widely followed index like the S&P 500 (INDEXSP:.INX), its stock tends to get two major benefits: A short-term price bump, and a cushion against big drops over the longer term.

Why? Because all of a sudden, there’s a whole new universe of big investors who may need to buy and hold the stock, namely index mutual funds and other portfolios that closely track the index.

Now, some of these portfolios use derivatives or complicated quantitative approaches to closely approximate the performance of the index they track, rather than holding stocks directly. But plenty still hold the stocks that make up the index – and they’ll continue to hold the stock even if the company hits a bump.

That’s what leads to the second benefit, that cushion. If a significant percentage of General Motors Company (NYSE:GM)’s stock is in portfolios that absolutely won’t sell the stock as long as it’s part of the index, then there’s a kind of built-in limit to the sell-off that might happen if GM’s business somehow stumbles.

Both of these things are good for individuals who are holding GM as a long-term investment. They’re also good for GM itself – both generally, and because of General Motors Company (NYSE:GM)’s unique situation.

GM had to work its way back in – with government help
GM, of course, was part of the S&P 500 (INDEXSP:.INX) and S&P 100 for many years. But it was booted out of the index when it went into bankruptcy, because old GM’s stock no longer had any value.

Post-bankruptcy GM has been public and profitable for a while now. But despite GM’s string of profitable quarters and increasingly solid balance sheet, GM didn’t qualify for reentry to the index because it failed to meet one of S&P’s key requirements.

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