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Many people have strong feelings for the pioneer of electric vehicles Tesla (NASDAQ: TSLA), both as a company and as an investment. The company headed by Elon Musk has generated much controversy over its history, but its skyrocketing share price has left its automotive colleagues in the dust.
The incredible stock run has produced 550% returns in the past year alone and over 9,500% earnings in Tesla’s roughly 10 years as a publicly traded company. This has led to a share price that many investors think is too high to pay.
However, even if you believe Tesla is not a buy right now, you may still end up acquiring some of its stock soon. This is because the company that manages one of the most followed stock indices in the world has just decided to add Tesla to it.
Image source: Tesla.
Tesla joins the S&P 500
S&P Dow Jones Indices is the entity behind it S&P 500 Index (SNPINDEX: ^ GSPC). The popular benchmark contains around 500 of the largest and most influential US companies, but its holding is not static. S&P Dow Jones often adds new components and removes old ones to reflect changing factors such as market capitalization, acquisition activity and other corporate events.
For a long time, Tesla was not eligible to join the S&P 500 despite its large market capitalization. Many of the formal requirements for inclusion, such as a minimum share price and an adequate free float, were no problem for the electric carmaker. The requirement Tesla took the longest to fulfill was that it had to be profitable for four consecutive quarters and for a period of 12 months.
However, even when this happened in early 2020, S&P Dow Jones didn’t immediately pull the trigger. Some experts have cited issues with the quality of Tesla’s profits, boosted as they are by regulatory credits. Others pointed to the complexity of adding a company to the S&P 500 that was already as big as Tesla.
S&P Dow Jones ended speculation on Monday when it said it would add Tesla to the S&P 500 effective December 21.
A couple of unusual things about adding Tesla to the S&P 500
However, the announcement wasn’t typical in a couple of respects. First, S&P Dow Jones hasn’t announced which Tesla company it will replace. He is putting off that decision until we are closer to the end-December rebalancing date.
Additionally, S&P Dow Jones has reached out to the investment community for precise guidance How to add Tesla. Given the size of the company – its market capitalization is in excess of $ 420 billion – this move has the potential to cause a massive disruption in indices trading. The index manager suggested the possibility of adding Tesla incrementally, possibly incorporating two separate dates in which portions of the final allocation would be entered into the S&P 500.
You would have done better to buy first
The irony here is that index fund investors who scoffed at Tesla’s purchase in early 2020 will end up paying much higher prices for the stock. Earlier this year, you could have bought Tesla stock at a split-adjusted price below $ 100. Until June, Tesla stock traded at less than $ 200 per share. But on Monday, Tesla closed above $ 400 per share – and jumped over $ 50 per share on S&P 500 news.
However, index funds have no choice. If they want to monitor the S&P 500, they will need to own Tesla stock, regardless of the premium they will pay to acquire them.
It’s not the end of the world
This isn’t the first time that investors have had to accept index fund additions they didn’t like. It happened with Facebook (NASDAQ: FB), but in hindsight, index investors need to be satisfied with the returns the social media giant has generated for their funds.
Plus, even with Tesla’s huge current size, its impact on your S&P 500 index fund won’t be that big. Tesla will likely end up with just over 1% weighting in most of these funds. That will make it the biggest news ever, but it doesn’t yet represent huge exposure to the automaker’s stock.
Tesla will continue to generate controversy and it is highly possible that the addition of S&P will be the next event that will trigger a massive food frenzy for the actions of the electric vehicle pioneer. Ultimately, however, what matters is whether Tesla can convert its incredible potential and expand into a business that justifies its industry-leading valuation.
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