Equity indices, such as the S&P/ASX 100 (ASX: XTO), 200 (ASX: XJO) and 300 (ASX: XKO), are constantly monitored by Standard and Poor's (S&P), and the constituents of each index are modified depending on the market capitalisation and relative liquidly of the stocks. As the market cap and liquidity of a stock increases or decreases, it may be moved between the indices by the S&P.
The share price of many mining and mining services companies have plunged in recent months, as fears have grown of the slowing Chinese economy, and the effect that reduced resources construction spending will have on company bottom lines. The market capitalisations have subsequently fallen to the point where some will now drop out of major indices such as the S&P/ASX 100.
Three such companies are Atlas Iron (ASX: AGO), Lynas Corporation (ASX: LYC) and Arrium (ASX: ARI). Investors are able to profit from this situation. Stocks that were unloved by fund managers in the S&P/ASX 100 index due to their small size may be of interest to small-cap fund managers due to their relatively large size compared to many small caps. This may result in a share price rise in the short term when it becomes available to small cap managers.
The Atlas Iron share price has dropped from $1.95 in December 2012 to a low of $0.69 in June, and has recovered well to just over $1.00 on Wednesday . The drop has resulted in the market cap dropping to around $750 million, which gives the company a ranking by market cap of 143 (ie it's the 143rd largest company on the ASX by market cap). S&P takes into account not only market cap, but also the relative liquidity of the company's shares. Relative liquidity is a measure of the liquidity of the stock compared to its peers, the calculation of which can be found here. The relative liquidity of Atlas was recently over 4 — a measure of 1 represents that it's as liquid as its peers. Its share price and liquidity should see it drop from the S&P/ASX 100 in coming months.
Similarly, Lynas Corporation and Arrium shares have fallen in price by 63% and 15% respectively over the past 12 months. This has resulted in the companies having ranking by market cap of 126 and 112 and a relative liquidity of 1.76 and 2.08 respectively. Lynas is at greater risk of dropping out of the S&P/ASX 100, while Arrium is unlikely to be removed based on its current statistics.
Foolish takeaway
Investors willing to accept greater risk may consider monitoring stocks susceptible to dropping out of, or rising into, major indices. Moving between indices may see increased investor demand and share price growth over the short term following any move. Atlas Iron and Lynas Corporation are likely to drop out of the S&P/ASX 100 and into an index where small-cap fund managers may see value in the risk profile and share price drop of the companies over the past 12 months.
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Motley Fool contributor Andrew Mudie does not own shares in any of the companies mentioned in this article.
