Tesla’s inclusion in the S&P 500 on 21 December is set to be the biggest in history with approximately $83bn flowing into the electric vehicle maker from index funds and ETFs alone, however, questions remain about the timing of the decision following Tesla’s performance this year.
On 16 November, S&P Dow Jones Indices (SPDJI) announced Tesla would be included in its flagship index, the S&P 500, prompting shares to jump over 13% during trading that day.
Following a consultation with market participants, SPDJI made the decision to add Tesla, which will account for 1.58% of the index, all at once by the end of trading this Friday.
The influence of decisions such as this has been clear to see with Tesla’s stock rising 52.6% since the announcement taking its market cap to $623bn, as at 16 December.
Overall, the car manufacturer has skyrocketed a whopping 624% this year following a significant increase in sales and positive quarterly profits.
However, whether a stock such as Tesla can maintain this performance remains to be seen and the timing could not be much worse considering the returns it has already posted, especially with a P/E of 96.5X.
Furthermore, having such a stock such as Tesla will only go to increase the overall volatility of the S&P 500, something ETF investors could be looking to avoid.
As Bloomberg columnist David Flicking said in an article last month: “It is very hard to see how Tesla will be able to justify those valuations in the long term. That is the case even if you agree with the most bullish analysts and assume the company will be producing about $10bn a year of net income by 2022 or 2023, compared with $556m over the past 12 months.
“On those numbers, a 20 times price-earnings multiple would produce a business worth not much more than half of Tesla’s current $387bn market cap.”
With such a high profile inclusion, the reputation of SPDJI’s index committee is certainly on the line. The index committee was thrown into the spotlight in September when it decided not to include Tesla in the S&P 500 despite Elon Musk’s company meeting the quantitative requirements.
But questions remain as to whether the decision should be left to a committee instead of implementing a rules-based approach.
The S&P 500 has been the index of choice for investors over the past decade delivering performance few active managers have been able to beat consistently.
However, the inclusion could serve to highlight the flaws in having such an active approach to selecting stocks to both include and axe.
As Vincent Deluard, global macro strategist at StoneX Group, said: “Like God and the Divine Providence, committees work in mysterious ways.
“The S&P 500 index is an actively-managed list of large-caps based on objective criteria (float, volume, revenues and earnings requirements) and subjective ones (representativeness of the US economy).
“Index providers and passive investors should try to replicate the market with minimum amount of distortion and frictions, rather than pursue vague and ambiguous goals such as ‘representing the US economy’.”