Will tesla join the s&p500?

Electric car manufacturer Tesla has easily been nabtrade’s most purchased international share in 2020, eclipsing more established players such as Apple, Amazon and Microsoft. Since January, the stock is up nearly 400%, blitzing the wider S&P500 and Nasdaq (now making record highs, despite their stunning falls in late February and early March). When Tesla shares exceeded $US2,000 for the first time in August, it was the most valuable car manufacturer in the world, despite producing a fraction of the cars of some of its more established competitors.

What many investors may not know, is that despite its enormous valuation, Tesla is not included in the S&P500, the most widely held index in the world. At a current market capitalisation of over $385bn, if added to the index today, Telsa would be in the top 10, likely coming in at number 9, behind Johnson and Johnson and pushing Walmart into tenth spot. The likely reason Tesla is yet to be added to the S&P500 is that Standard and Poors, the company that constructs the index, requires a company to be profitable before it is added, regardless of its market capitalisation. Hence a loss making company can be larger than Walmart (which earned $500bn more than Tesla last financial year) and still not included in the world’s most popular index.

As avid watchers would be aware, Tesla is no longer loss making, having now recorded four consecutive profitable quarters. Yet these results have not been sufficient to put Tesla into the index. S&P announced their latest update of index constituents last week, and while Teradyne, Etsy and Catalent have been added, Tesla received no mention. (For those interested, H&R Block, Coty and Kohls have fallen out of the index). S&P is under no obligation to add Tesla, despite it having reached all the obvious milestones, and gave no explanation for not having done so.

Why does this matter? Index managers and ETF providers hold approximately $US11trillion in S&P500-based products. Any passive manager is required to match the constituents of the underlying index, meaning they will need to sell H&R Block, Coty and Kohls, and buy Teradyne, Etsy and Catalent as soon as possible, or risk underperforming their benchmark (not a good look for an active manager, but fatal for an ETF or index fund provider). The sheer volume of funds flowing into passive strategies ensures that the underlying stocks receive consistent support in a rising market; being added to the index ensures a large inflow at the time of adding and ongoing flows.

For this reason, investors have been enthusiastically purchasing Telsa in anticipation of its addition to the benchmark. Over 10% of Telsa’s shares change hands on any given day, roughly 7-10x the turnover of Microsoft, making it one of the more liquid mega cap stocks. This liquidity could mean that the price will not move substantially if index managers are suddenly obligated to buy it, but investors have bet that buying on an unprecedented scale – it is estimated that Tesla will comprise 1-1.5% of the index – will drive the price substantially higher. News that Tesla was not included in the constituent reshuffle, announced after the close on Friday, resulted in a savage sell off in the after market.

In addition to the lure of being added to the benchmark, Tesla’s stock 5-1 stock split is perceived to be a major driver of its recent share price appreciation. The announcement itself led to a 20% rally in the Tesla share price, despite the fact that a split does not change the company’s fundamentals, nor its market capitalisation, and should therefore only deliver a 5-1 division of the share price. A split is ostensibly offered to allow smaller investors access to a stock with a price that may now be out of reach (think Berkshire Hathaway, where Class A shares cost more than $US300,000). Although with fractional investing now available through many large retail brokers in the US, this is less of an issue than it used to be. Given its heavy retail shareholder base, Tesla has simply become even more appealing to individual investors.

So does this mean for investors? A few things. Firstly, if you are investing in an index, ensure you understand how it is constructed and that it contains all the companies you wish to invest in. (Tesla’s share price performance has vastly outstripped the wider index in 2020). Second, be aware that many factors – other than fundamentals or even company outlook – can drive a share price. Tesla is famously one of the most shorted stocks on the exchange, and what goes up, may come down.