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Many companies are flailing just now, struggling to keep afloat during the coronavirus pandemic. DocuSign (NASDAQ: DOCU) is not one of them. It’s been a fundamental star and a stock market standout because its core e-signature solutions are entirely digital and thus basically pandemic-proof. Combine that with a world that keeps adding to the volume of important documentation online, and you’ve got a winning stock.
And lately you’ve got a Nasdaq-100 stock, too. Last month, Nasdaq (NASDAQ: NDAQ) tapped DocuSign for the index, taking the slot held by United Airlines. The Nasdaq-100 is the signature (sorry!) large-cap stock index composed of the exchange’s more prominent listed companies. Therefore, DocuSign has vaulted to the top of the Nasdaq pyramid; let’s see if joining the top-shelf index alone makes the company a buy.
How to get on the Nasdaq-100
All of the Nasdaq-100’s stocks are large caps, generally defined as stocks worth at least $10 billion (although this index has no official minimum requirement). It usually takes time for any stock to become popular and successful enough to rise that high — even in the rapid-fire tech industry that crowds both the Nasdaq overall and its most important index (more than half of the Nasdaq-100’s component companies are in that sector).
By the standards of the index, $10 billion is actually small potatoes. In fact, we might even say the same of DocuSign’s nearly $39 billion. If we look at the most richly capitalized Nasdaq-100 names we can see mighty Apple (NASDAQ: AAPL) at a dizzying $1.66 trillion and massive Amazon.com (NASDAQ: AMZN) standing very tall at $1.59 trillion. That’s trillion with a “t,” in both cases.
Think of the hard roads both Apple and Amazon have taken, though.
Apple went through a long period of stagnation and near-irrelevancy between the two leadership stints of rock star cofounder Steve Jobs. During his second tenure, after some time, Jobs felt compelled to reposition the company mainly as a state-of-the-art consumer electronics purveyor with the iEverything suite of goods and accompanying product ecosystem.
Amazon long-term investors had to endure what felt like quarter after quarter of losses as the company steadily spread across retail categories and built scale to reach its currently dominant position atop Mount eCommerce. And now, think of it: Has there been a single day where your household, or those of your neighbors, hasn’t had an Amazon package placed in front of it?
Index inclusion effect: fact or fiction?
The point of all this is that the components of any large-cap index are companies that needed time and resources — frequently quite a bit of both — to become at least glancingly familiar to investors. The Nasdaq-100 is no different.
That’s why major index inclusion is not an automatic and sustained value booster on its own. While there are numerous instances of stocks getting a nice pop when their addition is announced (like DocuSign, which rose a sturdy 8% on the first trading day following the Nasdaq’s after-hours announcement), it’s a short-term sugar rush at best. That sharp upward momentum rarely — if ever — lasts.
I haven’t conducted a comprehensive survey, but most of the research I’ve seen on the “index inclusion effect” draws broadly the same conclusion. Put succinctly, there’s really no sustained increase in a stock’s value purely from being tapped for an elite grouping.
There’s little reason why it should; investors rarely want to stay in, or buy, the stock of any company suffering from eroding fundamentals and poor strategy. At that point, who cares what famous index it’s a part of?
The converse is true of a DocuSign, say, which has lately attracted investors because of strong double-digit revenue growth and a non-GAAP bottom line that has landed well in the black. If the company does as well in its coming quarters as it did in the last one, it will surely continue to be a hot stock. Eager buyers won’t snap it up only because it’s a Nasdaq-100 name. Some might not even know that; few will care.
So at the end of the day, while inclusion on an index draws attention to a stock, it should be considered basically a graduation onto a bigger stage with a hotter spotlight. A company still has to perform to or above expectations, and that’s where the growth in value — or lack thereof — will ultimately come from.
This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.
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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.