The New Kid in Town

TSLA's Membership & Potential Membership in Key Large Cap Equity Indices 

^{Source: Factset; internal estimates. Data as of August 24, 2020}

Why is Tesla absent from the S&P 500 index while it has been included in most other major US Large Cap Equity indexes? The S&P 500 is a breed apart. Unlike the other benchmarks that have already included Tesla in their indices, inclusion in the S&P indices in not purely rules-driven and systematic; rather inclusion is determined by a committee at S&P’s discretion. We will dissect some of the mystery around S&P’s index selection process, provide color on S&P’s criteria around the potential add, and discuss the impact to the market of Tesla joining the S&P 500 index.

The S&P 500 index selection criteria contains both quantitative and qualitative aspects. The quantitative factors include positive net income and four consecutive quarters of positive net income. For the second quarter of 2020, Tesla reported positive GAAP net income of $104 million, as well as positive net income for the sum of the latest four quarters. With this milestone, the company now meets all quantitative criteria for inclusion in the S&P 500 index.

Despite meeting the quantitative criteria for inclusion, Tesla’s addition to the S&P 500^® is not yet a foregone conclusion given the qualitative dimension of S&P’s inclusion criteria. The quality of earnings could be a key issue with the committee. Tesla’s positive profitability has been driven by the sale of regulatory credits to other auto manufacturers who need offsets in order to reach their emissions standards. For the second quarter of 2020, they recorded $428 million in revenue from the sale of emissions credits against GAAP net income of only $104 million.

Volatility in Tesla’s stock price may be another key issue for the committee and concerns about the sustainability of the company’s returns. Year-to-date through August 24, 2020, Tesla has risen +384.5% while the S&P 500 has risen by 7.6%. Over the past twelve months, the stock skyrocketed by +852.8%. It is these qualitative considerations that give rise to speculation to its addition.

Performance Comparison of Tesla vs S&P 500

^{Source: Bloomberg. Data as of August 24, 2020.}

If S&P moves forward with adding Tesla to the S&P 500, the most likely date for inclusion would be during the next quarterly rebalance scheduled for the close of September 18, 2020. As the September rebalance also includes S&P’s annual free float review, the announcement could come as soon as the close of September 4, 2020 which would most likely spark continued run-up in the stock price.

We estimate that Tesla’s projected weight in the S&P 500 could be between 1.15-1.25% of the index, depending on S&P’s adjustments for free float and based on Tesla’s closing price of 2,014.20 as of August 24, 2020. This would rank it around twelfth in the index by weight, ahead of such notable names such as Disney, Pfizer, Intel and Coca-Cola. This would also rank Tesla as one of the top three largest additions to the S&P 500 over the past 26 years, rivaling the addition of Berkshire Hathaway (2010) and surpassing Microsoft (1994), Google (2006), and Facebook (2013). In terms of new additions to the S&P 500, this would rank as the largest in the past 16 years.

Though Tesla carries a lofty market capitalization of $400 billion, the trading impact of adding it to the S&P 500 is expected to be manageable. According to S&P’s estimates, there were approximately $11.2 trillion of assets under management either benchmarked against or indexed to the S&P 500 as of July 31, 2020. Of this total, indexed assets comprised $4.6 trillion. Using the above projected weightings for Tesla, index managers in aggregate would need to add between $53 to $58 billion in TSLA exposure (roughly 26 to 28 million shares); representing about 2.1x average daily volume for the 30 days ending August 24, 2020. 

As index managers with over $300bn in index assets, the importance of understanding the rules around index inclusions and the potential market impact of large events such as Tesla’s future inclusion is what we do every day. We will be ready for Tesla to join the S&P 500 whenever the S&P Committee makes it final determination.