Will Tesla soon be a member of the S&P 500?

Tesla has been racing past one milestone after another like a P100D on a deserted freeway. The stock has soared far beyond previous highs, bringing the company’s market capitalization (last week) to over $115 billion. The young disruptor is now worth more than the two elder statesmen GM and Ford combined. In fact, it’s now the second-most valuable carmaker in the world, behind only Toyota.

Above: A look at the Tesla Model 3 (Source: EVANNEX; Photo: Casey Murphy)

However, there’s one major financial honor Tesla has yet to earn - membership in the S&P 500 - and it’s possible that the brash upstart may crash this elite club before the end of this year.

The Standard & Poor’s 500 index, which measures the stock performance of 500 of the largest US companies, is used by investors to gauge the performance of the overall stock market. It’s designed to be representative of US industry, and is generally considered a good general indicator of the nation’s economic situation.

Tesla is tantalizingly close to qualifying for the club - it’s currently the most valuable US firm that is not an S&P 500 member. To be included in the index, a company must meet eight primary criteria having to do with market capitalization, liquidity, financial viability and other factors, and Tesla already meets most of these. However, there’s a pesky little requirement about earnings: the sum of a company’s most recent four consecutive quarters’ earnings must be positive, and so must the most recent quarter.

This is a feat Tesla has yet to achieve. Historically, the company’s profitable quarters have been few, and have been interspersed with losses. However, with two consecutive quarters of profit under its belt, Tesla is on a roll that could catapult it into the 500. The bottom line: if Tesla manages two more consecutive quarters of profit, it should be eligible for inclusion in the S&P 500 in the second half of this year.

This is good news for TSLA investors, and not just for bragging rights. Membership in the 500 tends to boost a company’s stock price, because it guarantees a certain amount of demand for the shares. Index funds are required to own shares in all the S&P 500 companies, and these represent a vast amount of money, especially from institutional investors. Joining the 500 can provide not only a long-term lift, but also an instant turbocharge: when Twitter became a member in 2018, its stock ran up some 60%.

Above: Tesla is poised, potentially, for S&P 500 inclusion based on a number of factors (YouTube: NEXT Travel Stream)

Does this mean it’s time to buy? Probably not. As every savvy investor knows, stock prices never reflect the present - they reflect expectations for the future. The likelihood of Tesla joining the 500 is common knowledge, as is the tremendous potential of the Chinese Gigafactory, Model Y, Cybertruck, etc, etc, etc. All of these promising prospects are already “baked in” to the stock price.

As MarketWatch’s Jeff Reeves put it, TSLA is “perhaps the most closely watched stock in investing, and it’s almost willfully naive at this point to presume you see some angle that isn’t fully reflected in the stock price.” In fact, many believe that TSLA’s stratospheric stock price reflects not just optimism but over-optimism. Long-time stock watchers know a hockey-stick breakout often takes on a life of its own, as the bandwagon crowd propels prices far beyond what even the most spectacular product prospects could justify. Reeves also points out that the short sellers, despite losing whole retail districts full of shirts, are still a factor, and it may be that not all of them are “Luddite stooges.”

Does this mean it’s time to sell? Probably not. Reeves cites a a white paper from the National Bureau of Economic Research that found a clear correlation between stock performance and inclusion in popular indexes. At its current valuation, Tesla would merit a weighting of about 0.35% in the S&P 500 index. There’s almost $10 trillion worth of investment benchmarked to the S&P 500, so (to oversimplify a bit), S&P 500 member Tesla could be exposed to some $35 billion in potential investment.

So, whatever the stock does in the short term, joining the elite index would surely give TSLA a tremendous tailwind. How likely is it that the company will pull off the requisite two more quarters of profit? A recent article in Zacks took a look at some of the factors that should support earnings this year.

Demand for Model 3 continues to be high - Tesla delivered 367,500 units in 2019, and expects to deliver 500,000 this year. Higher volumes should enable cost and production efficiencies, which translate to stronger margins. And Tesla has proven to be very good at eking out savings by cutting costs and continually making production more efficient - it shaved operating expenses by 6.6% In 2019. Falling battery cell costs could turbocharge the trend. And don’t forget Tesla Energy - solar and storage deployments are expected to grow by 50% in 2020 - or Model Y, which could be the company’s most popular vehicle yet.

However, Zacks also sounded a few notes of caution - Tesla will need a lot of cash for capital investments in the year ahead, and it still has substantial debt. And an economic slowdown in China could spoil the soup in a big way.

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Written by: Charles Morris