September 11th, 2020 by Frugal Moogal
Note: Nothing below is investment advice.
I’ve been thinking about writing this article for a while, but have held off because of how enthusiastic the overall market has been about the potential for Tesla to be included in the S&P 500. I’ve avoided addressing it in my other articles so far because — spoiler — I don’t think it really matters.
Then, on September 4th, Tesla wasn’t included in the latest S&P note, and the share price fell by 21% on Tuesday when the market reopened, sort of proving me wrong. Clearly, a number of shareholders who bought expecting to cash out when the stock received an inevitable bump on September 9th dumped it, right?
Well, probably, but the whole belief in this bump was odd to me, and it’s why I think that you need to always keep in mind a long-term horizon for your investments, and why I don’t like to try to time any short term stuff. As I write this, two days later, Tesla has gained back two-thirds of what it had lost, making the loss since Friday about 8%, or a gain of about 37% over the past month, which is still an insane — and, quite frankly, I expect unsustainable — return.
During the same time, Tesla has sold additional stock to raise an additional $5 billion in cash, which means that the shares were diluted during this period.
But let’s take a step back and take a critical look at what the S&P 500 inclusion would have done for Tesla for a moment.
Is There an S&P 500 Index Effect?
If you’re ready for a little big of “light” reading, there is an outstanding 55 page research paper from the Federal Reserve Bank of New York that was published in February of 2011. It can be found here (pdf).
I’m going to assume most people aren’t going to read it, so below are a couple pieces of information I find particularly important. On page 1 of the report (3 of the PDF):
“In this paper, we document that index-included firms exhibit extraordinary pre-event performance, such as large increases in earnings per share (EPS), appreciation in market value, positive price momentum and decline in book-to-market ratio (BM).”
And, on page 2 (4):
“We find that the permanent value effect is predictable on the basis of pre-inclusion information: (i) the average daily return in the pre-inclusion year and (ii) the pre-inclusion revision of analysts’ EPS forecasts for the fiscal year of index inclusion.”
“But wait!” I already hear some complain. When Yahoo was included in the S&P 500, shares surged 24%! Wasn’t Tesla set to skyrocket like Yahoo did? That’s what everyone else made it sound like!
Cherry-Picked Data
I often dismiss Tesla bears for cherry picking their data to try to make a case against the company that doesn’t stand up to scrutiny, but in this case I worry that the bulls were doing the same thing. It’s true that Yahoo did spike, but that often isn’t the case. In fact, let’s take a look at the companies that were included in the announcement last Friday, September 4th:
- Etsy — The handmade craft marketplace, closed at $112.04 on Friday. Upon learning they were included in the S&P 500, on the first day of trading after the announcement, they “spiked” to $113.38 at open, before closing at $110.56.
- Teradyne — This automation and robotics company closed at $78.60 on Friday. After the announcement, they began trading at $76.15 and closed at $75.53.
- Catalent — This pharmaceutical developer ended Friday with their share price at $83.95, before opening after they were announced for the S&P 500 at $81.24, and closing the day at $83.09.
Using the data above, on the day following the announcement of their inclusion:
- Etsy opened up 1.19% and closed down 1.32%.
- Teradyne opened down 3.12% and closed down 3.91%.
- Catalent opened down 3.23% and closed down 1.02%
All three companies that were included in the S&P 500 ended their first day of trading at less than before they were announced. But, if you were to listen to all the Tesla bulls that laid out great arguments about how Tesla would spike like Yahoo did, you might have overlooked the fact that the majority of companies do no such thing.
What Does It Mean?
Of course, the lack of inclusion has Tesla bears celebrating — ignoring that Tesla’s stock price at close on September 8th, the day after the changes were announced, is still up 13.65% compared to its closing price on August 7th. According to the bears, the S&P 500 committee believes there is a problem with Tesla.
Sorry to be the bearer of bad news for everyone here, but I don’t think that the lack of S&P inclusion means anything in particular. The committee can decide to include or not include pretty much whatever it wants.
Tesla’s $350+ billion market cap as I write this seems to indicate the company is doing okay at the moment. The stock selloff on Tuesday that lost the company about 21% of it’s value was an interesting almost inverse parallel to Yahoo’s inclusion, in which it gained 24%, but the only real takeaway I have from that is that far too many investors had bought into the hype that S&P inclusion would mean a huge bump in price, and then they sold figuring that the lack of inclusion would cause a decline. It was a self-fulfilling prophecy.
It also indicates to me that inclusion wouldn’t have meant much to long-term investors, as many of the investors seemed poised to sell and lock in profits. It’s true that we probably wouldn’t have seen such a steep selloff on a “normal day” — it was a bad day for the entire stock market — but I honestly doubt we would have seen Tesla close up anyway.
Conclusion
I firmly believe the most important thing to understand about S&P 500 inclusion can be found in that first quote from the Federal Reserve Bank of New York Report — that before a company is granted S&P 500 inclusion, their shares generally exhibit extraordinary performance anyway. S&P inclusion shouldn’t be the cause of valuation spikes, it should be the result of it.
Additionally, taking the lessons of a dotcom stock during the dotcom bubble and applying that to Tesla is wrong to me on many, many levels.
Wouldn’t I like it if Tesla was included on the S&P 500? Honestly, I don’t care.
I’d much rather we discuss the impact of future product releases on earnings, production and delivery estimates, the production rates of the Gigafactories, why Tesla is choosing to hide over half a billion dollars of profit in warranty accounting, or practically anything else that actually impacts the company results, instead of an external label which will change nothing about how the company operates.
For now, Tesla isn’t included on the S&P 500. Now what?
I simply expect Tesla will continue to deliver on the items that has driven their share price over 800% higher in the past year. That’s why I invested in the company to begin with. I don’t know (nor do I expect) another 800% gain in the next year, but whatever is going to happen on battery investor day is far more exciting to me than whatever some committee decides about if the company should get put into its investment list or not.
Disclaimer
I am a Tesla [NASDAQ:TSLA] shareholder who has purchased shares within the preceding 12 months. Research I do for articles, including this article, may compel me to increase or decrease stock positions. However, I will not do so within 48 hours after any article is published in which I discuss matters that I feel may materially affect stock price. I do not believe that my voice could or should influence stock price by itself, and I strongly caution anyone against using my work as your sole data point to choose to invest or divest in any company. My articles are my opinion, which was formulated using research based on publicly available data. However, my research or conclusions may be incorrect.
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About the Author
Frugal Moogal A businessman first, the Frugal Moogal looks at EVs from the perspective of a business. Having worked in multiple industries and in roles that managed significant money, he believes that the way to convince people that the EV revolution is here is by looking at the vehicles like a business would.