Developing Models to Predict Constituent Changes (Exclusion/Inclusion) of Securities in NIFTY 50 Index for Maximizing Investment Returns

A Common Observation regarding stock price behavior pre and post inclusion and exclusion of a company into indices is that share prices tend to increase prior to inclusion and decrease prior to exclusion. Although Eligibility criteria for inclusion and exclusion include Impact Cost (Liquidity), Market Capitalization, Domicile, Eligible types of Securities and Free Float but still if we can devise models that predict inclusion or exclusion using certain key performance indicator that are widely available, then, the stock market can surely provide a lot of scope for making money for the equity investors. This research work aims at developing two such models. Model-1 predicts with extreme accuracy whether or not any company from the existing 50 companies in Nifty Index will be excluded in the near future and Model-2 predicts if a company will be included as Nifty constituent using discriminant analysis. The KPIs used for the purpose of study include Rate of growth of Profit after tax (ROG-PAT), Rate of growth of Net Sales (ROG-SALES), Rate of growth of Market Capitalization (ROG-MCAP) and Interest Coverage Ratio (ICR). The model proposes a range of outcome values which can be used to predict inclusion or exclusion from NIFTY. A long (buy) position if taken in the securities that are predicted by the model to be included in the index, will help in generating higher returns as its financial performance will improve before the inclusion leading to higher stock price. Alternately, a short (sell) position taken in the securities that are predicted by the model to be excluded from the index, will also be a good bet as its financial performance will degrade before the exclusion, leading to lower stock price.