How a stock goes into an index

First, how a stock can be included in the Index?

$Straits Times Index(STI.SI)$ 

A stock can be included in the Index because they have grown to reach a certain market capitalization that allows it to be given a place in the Index. The real use of the index is to provide an objective picture to investors of the direction of the stock market movement.

Usually the companies that are in the Index have reached a high level of maturity to a point that we no longer need to question their fundamental quality. This is because based on its market capitalization, it is so large that it should not be possible to achieve unless if the company in question does have quality.

In other words, the Index actually represents the best quality stocks in Malaysia in particular and represents the prosperity of the stock market in Malaysia in general.

Second, what if I invest in stocks outside the Index?

In fact, there is no problem if an investor chooses to invest in stocks that are in the Index or even outside the Index. Each one has its own advantages.

If an investor chooses to invest in stocks that are in the Index, he does not need to worry about the fundamental quality of the stock because the ability of the stock to be included in the index already shows that it has good fundamental quality.

However, due to the fact that mature companies are usually included in the index, these companies do not have high growth. Therefore, an investor should not have high expectations that such stocks will give them a high return in terms of capital appreciation.

Nevertheless, such companies are usually able to give high dividends. This is because without high expenses for growth, the retained earnings of these companies will be high and it can be used to pay handsome dividends to investors.

On the other hand, if an investor chooses to invest in a stock that is not in the Index, he may need to do a more careful study of the fundamental quality of the stock because the ability of the stock has not yet been proven.

Since mature companies usually resides in the Index, people who invest stocks outside the Index will often find that these companies can have high growth. Therefore, an investor can expect a high return in terms of capital appreciation.

However, such companies rarely give high dividends. This is because with the high expenses used to increase growth, the retained earnings of these companies will be more limited and will make it difficult to pay dividends.

Nice article