Deliveroo PLC's (LSE:ROO) inclusion into the FTSE 250 set of companies seems bolted on following what at face value was a pedestrian category change.
Currently at a £2.5 billion valuation, Deliveroo PLC (LSE:ROO) fits firmly in the upper half of the FTSE 250 set of companies.
However, index inclusion has evaded the food-delivery player since its 2021 initial public offer.
This is not because Deliveroo’s IPO was something of a disaster (which it was), but because of how the UK’s listing rules have historically operated.
Until July of this year, the official list of securities traded on the London Stock Exchange had been split into ‘standard’ and ‘premium’ segments.
Standard listings came with fewer reporting and regulatory requirements, but they were also precluded from the FTSE Russell suite of indexes.
This stratified approach to listed securities was replaced by a single ‘equity shares (commercial companies)’ (ESCC) category by the Financial Conduct Authority as part of a sweeping overhaul of stock market regulations.
These reforms were part of broader plans to enhance London's attractiveness as a listing venue at a time when international interest was — and still is — wavering.
Since the July overhaul, legacy standard listings were placed in an interim ‘equity shares (transition)’ category to allow companies time to fulfil their obligations under the new unified listing regime.
Deliveroo has evidently fulfilled these obligations given its announcement that shares are now listed under the ESCC category with the London Stock Exchange.
To simplify the above: Deliveroo was previously ineligible for a FTSE 250 listing. Now it is.
So what?
But does index inclusion have any impact on a company’s investment thesis?
The ‘index inclusion effect’ theory posits that yes, inclusion into a major index can positively affect a stock’s valuation.
A large body of research suggests that this theory has some truth to it, but any positive upswing is usually temporary.
Analyses from McKinsey, Harvard and the Federal Reserve Bank of New York attest to this.
Furthermore, as the National Bureau of Economic Research pointed out, share price upswings post-index inclusion are likely to be a result of improving business fundamentals that led to index inclusion in the first place.
This is not necessarily the case for Deliveroo, though. Index inclusion, if it happens, will be a result of a regulatory shift as opposed to improved fundamentals.
This makes for a unique situation.
Panmure Liberum analysts recently suggested that FTSE 250 inclusion is “the next likely upside scenario” for Deliveroo, but the broker’s viewpoint is not universal.
“Anyone preparing to buy ROO stock purely on the basis of index admission needs to proceed with caution,” said AJ Bell’s investment director Russ Mould.
His warning is not without precedent.
The ASOS case
ASOS’s promotion from the junior AIM market to the FTSE 250 in spring 2022 was supposedly the next big catalyst for ASOS shares.
“Cue profit warnings, a share price collapse and ejection from the FTSE 250 barely 15 months later,” Mould pointed out. ASOS shares remain 75% below what they were from this supposed catalyst.
ASOS and Deliveroo are vastly different companies and these are vastly different case studies, but the lesson is universal.
“What really matters is the competitive position of the business and a company's ability to win and keep customers effectively,” said Mould.
“Does index inclusion affect ANY of these fundamental considerations that will ultimately determine long-term equity returns?
“I don't think so, myself. If anyone thinks there is a trade to be made – and trading is very different from investing, in my opinion – then good luck to them but they should bear in mind that ASOS chart if they have a go."