Tesla makes it into the S&P 500 — Here’s how its stock could be impacted

Despite meeting all requirements to join the S&P 500 and being left out in September, it’s been announced that Tesla will finally be added to the S&P 500, an index of the 500 largest companies in the US, on Dec. 21.

In case you didn’t know

Since the S&P 500 is an index, investors can’t invest directly into it, but instead can invest in funds or ETFs that replicate the S&P 500 — e.g. SPDR S&P 500 ETF Trust ($SPY), iShare Core S&P 500 ETF ($IVV), etc.

Funds and ETFs replicating the S&P 500 have over $11t invested in them.

If the composition of the index changes (i.e. switching one company out for another), all these funds are required to buy and sell certain companies to match the new structure.

Fund managers’ biggest headache

Enter Tesla, the largest company at the time of entry, who will make up more than 1% of the S&P 500 once added.

In July, Vanguard Group estimated that fund managers will have to sell $35-40b of other companies in the index to fit Tesla in the index.

In turn, these managers will also need to buy Tesla stock to match the S&P 500’s composition — Tesla’s stock rose over 10% as a result of the expected demand.

Catchup: Benefits of joining the S&P 500 and why Tesla didn’t make the cut in Jan

For investors… Tesla moving forward?

As we previously wrote, between 1997 – 2007, stock prices of newly added companies increased by up to 4.9% in the first week. Between 2007 – 2017, this initial increase dropped to 0.7%.

Wait for it… from 1997 – 2017, stock prices fell on average over the next 12 months after a company joined the S&P 500.

But Tesla and CEO, Elon Musk, has so far defied all investor odds:

• Going from near bankruptcy while ramping up Model 3 production between 2017 – 2019, to generating a full year of profits in 2020.
• Tesla’s stock grew nearly 5x in 2020 despite all the controversies surrounding its CEO’s behavior.

2 analysts’ takes on the future of Tesla:

But the topic of concern — Tesla’s valuation. The company is now worth more than Volkswagen, Toyota and General Motors combined.

• The bull case: According to JMP Securities analyst, Joseph Osha, Tesla should be treated like a “category killer” like Apple instead of being valued like other car makers — suggesting Tesla is not overpriced.
• The bear case: According to Bloomberg Opinion columnist, David Fickling, Tesla will need to produce over $10b a year in net income by 2022/2023 to be worth about half of what it’s currently worth.

It’s likely that Tesla will need to become more than just a car maker to justify its current valuation — e.g. licensing its software or selling its batteries to other car makers.

Learn more: Tesla’s has a big problem — too much demand for its products