Why Tesla’s Debut on the S&P 500 Matters

A Quick Review

Earlier this week, news broke that Tesla (TSLA) will join the S&P 500 on December 21. Investors had hoped the electric car maker would earn a spot in the S&P 500 in September after it reported a fourth consecutive profitable quarter, meeting an important requirement for joining the index. However, the S&P Index committee does not automatically include companies once they have met requirements, and Tesla was not added to the index after the third quarter rebalance.

After the disappointment in September, investors are cheering this week’s news. Tesla, which was once a niche startup, has achieved important recognition from both the automobile industry establishment and Wall Street. Leading up to September, shares of the electric vehicle maker climbed about 74% as investors hoped the company would be added to the S&P. After the news that Tesla did not make the cut in September, shares fell about 14%. Now, investors are wondering what lies ahead for the company.

Investors Look Ahead

Bullish Tesla investors expect indexation to boost demand for shares of the company, along with the price of those shares. Roughly $12 trillion in mutual fund assets are indexed to the S&P 500. This means that index funds will buy approximately $100 billion in Tesla stock. This could lift the company’s share price for a few trading days. However, share prices tend to level off after index funds make their initial purchases. For context, Tesla shares bucked the negative bias yesterday, gaining 8.21%.

Joining the S&P does not guarantee that Tesla will continue to perform as well as it has this year. Bullish investors say Tesla could produce $10 billion in net income by 2022, up from the $226 million it has made over the past 12 months. On the other hand, less-optimistic investors see that the EV industry is getting more crowded and are wary that Tesla could get passed by a smaller competitor. In the late 90s, Yahoo (then YHOO, but now AABA) looked like it would dominate the search engine landscape until a lesser-known startup, Google (GOOGL) came along. Some investors worry the same could happen to Tesla.

Tesla Will Be the Largest Company Ever Added to the Index

Tesla, which has a market value of nearly $390 billion, will be the largest company ever added to the S&P 500. Because the EV maker is so big, if it were added all at once, index-tracking funds would need to sell over $40 billion worth of other stocks in order to make room for Tesla.

Tesla will be one of the top 10 largest stocks in the index, with a weighting of over 1%. Usually when a new company is added, it is swapped for another company of a similar size, but there is no stock that the S&P 500 could conceivably remove to offset Tesla’s entry into the index. For this reason, the S&P 500 may decide to phase Tesla into the index in stages. It’s been a winding road to the S&P 500 for Tesla, and there are likely more ups and downs ahead for the company and its investors.

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