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IN IT TO WIN IT

Why Tesla’s inclusion in the S&P 500 index matters

Tesla Inc CEO Elon Musk dances onstage during a delivery event for Tesla China-made Model 3 cars in Shanghai, China January 7, 2020.
Reuters/Aly Song
  • John Detrixhe
By John Detrixhe

Future of finance reporter

Tesla, the electric-car maker with a market value of $630 billion, joined the Standard & Poor’s 500 index today.

So what does that mean for Tesla shares?

The S&P 500 is widely seen as the benchmark for large US stocks and one of the most important stock-market gauges in the world. Many money managers are judged by how well they perform against the S&P, giving them an incentive to own Tesla to avoid deviating from the index. Likewise, a host of index funds are also linked to it and will automatically add Tesla shares so they can track it as closely as possible. S&P estimates that more than $11 trillion worth of assets are benchmarked to the S&P 500.

“Active portfolio managers that are benchmarked to that index are going to have to look at Tesla and care about Tesla,” says Phil Mackintosh, chief economist at stock exchange operator Nasdaq. “The S&P returns we see on television are going to reflect, partly, Tesla performance every day.”

Tesla is big in the stock market, but so is the S&P 500 Index, which has a market capitalization of around $30 trillion. Elon Musk’s company will make up about 1% of the index, slightly less than the 1.3% weight that Warren Buffett’s Berkshire Hathaway had when it was added in 2010.

Does this mean Tesla stock, which has rallied a mind-boggling 700% or so this year, will climb even higher? There’s a lot of research on this because S&P 500 additions happen fairly often. New additions climb about 5% or so on average from the time of the announcement of their inclusion in the index, Mackintosh says. That jump usually takes place quickly after the news gets released. But Tesla’s increase has been much bigger—as much as 14%. Some of that exuberance seemed to have burned off in early morning trading today, as shares were down about 5% before the stock market opened.

When a stock joins the S&P 500, it can become more liquid, meaning it’s easier to trade large chunks of the company’s equity without causing prices to gyrate. There are futures, which allow traders to hedge or speculate on a stock’s price at some later date, tied to the S&P benchmark, which also helps make buying and selling more efficient. “Liquidity broadly picks up,” Mackintosh said.

One of the requirements to be included in the S&P 500 is that a company’s most recent quarterly earnings and the sum of its most recent four consecutive quarters’ of earnings must be positive. Musk’s company can tick that box, but its profits would look a lot different if not for the sale of regulatory credits tied to pollution.

Experts have questioned the benefits of S&P’s profit requirements for index inclusion, Mackintosh says. The rule kept Google out of the flagship US stock benchmark for a number of years. (It was finally added to the S&P in 2006.) “A lot of the big growing companies enter the S&P quite late because of that rule,” he says.

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