GM headquarters in Detroit. Photo credit: General Motors Company (NYSE:GM).
Four years after being kicked out of the S&P 500 Index, General 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.
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.
Before being eligible to join the index, S&P requires a market cap of at least $4 billion (GM’s is about $48 billion), four consecutive profitable quarters (GM has had 13 and counting), and at least six months of trading following an IPO (GM’s IPO was in November of 2010).
General Motors Company (NYSE:GM) obviously has had all of that covered for a while. But S&P also requires that at least 50% of a company’s stock be “free float”, which is to say trading in the open market. That’s what held GM back: The U.S. Treasury’s holdings of GM stock, a legacy of GM’s $49.5 billion bailout, meant that GM’s free float was less than 50% of the shares outstanding.
GM’s free float was just over 44% as of the beginning of 2012. But now, with the Treasury in the process of selling off its stake in GM, the company’s free float has risen over 50%. It’s probably in the neighborhood of 51.5 to 52% now. That’s good enough for S&P.
So why is this good for GM?
It’s good for GM for all of the obvious reasons. It’ll boost the stock, which means that GM could raise more money by selling more stock if necessary. And it’s a seal of approval that will enhance GM’s creditability with investors and with Wall Street generally, which can’t be bad for GM’s ongoing business.
But it’s also a boon because the boost to GM’s share price will make the government’s exit that much more profitable. The U.S. Treasury began selling off its GM holdings earlier this year, and plans to have them all sold by sometime early next year.
At current prices, the government is almost certain to take a loss on its “investment” in GM, perhaps as much as $10 billion or more. But GM’s stock has been rising since the government started selling – it’s up about 18% so far in 2013.
It’s unlikely to rise enough to give the government a profit, of course. At this point, that would require a share price well over $70. But every bit helps – and from GM’s perspective, the sooner the government is “paid back”, the better.
The article S&P Gives GM’s Stock a Boost originally appeared on Fool.com is written by John Rosevear.
Fool contributor John Rosevear owns shares of General Motors. Follow him on Twitter at @jrosevear. The Motley Fool recommends General Motors and H.J. Heinz Company.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
