Tesla ready to plug in to the S&P 500
The S&P500 is a stock index. An index is simply a weighted average of a bunch of underlying stocks, allowing investors to track how an overall market is doing.
Every index has certain rules for inclusion. The starting point is usually (but not always) a specific stock market (e.g. the JSE) followed by a sorting system (by industry e.g. the JSE Financial Index or by size e.g. the JSE Top 40).
The S&P500 is the go-to index for US stocks and has been calculated since 1957. It’s always in the news, but especially so lately in the context of Tesla.
In this article, I touch on the basics of a stock index and some major concerns I have with Tesla.
A living, breathing organism
The index is rebalanced quarterly by a committee that assesses stocks for inclusion. They consider stocks listed on several exchanges, of which the Nasdaq and New York Stock Exchange are the most important.
This “rebalancing” means that some companies are included and others are kicked out based on the rules of the index.
There are other rules too, related to market cap and % of assets and revenues in the United States. In this incredible world of huge valuations for tech companies that make losses, it’s also important to note that a company must have four consecutive quarters of positive earnings.
There’s where Tesla comes in.
Float your boat
The S&P500 is a float-adjusted index, which means it weights companies in the index based on shares available to the public. The “float” of a company is the tradeable number of shares and excludes shares held by controlling and large strategic shareholders.
For example, stock held by Bezos in Amazon (or Musk in Tesla) would be excluded, because those shares are not traded in the ordinary course of things.
So, the largest and most liquid shares (because of a high float) would carry a higher weight in the S&P500.
The value of inclusion
It’s a big deal to be included in the index. Apart from the obvious status benefit that it brings, index tracker funds are forced to buy the shares of companies that enter the index, as their only mandate is to perfectly replicate the index for investors.
This is part of why Tesla’s share price has run so hard. Investors were hoping that Tesla would finally achieve four consecutive quarters of profit, which would make it eligible for the S&P 500. The incredible irony is that it will enter the S&P 500 among the largest companies in the index as the value is so high!
This increases demand for Tesla’s shares, which naturally increases the price. Much of this may have been “priced-in” though as investors believed fully in the profitability story and the index inclusion.
What if Tesla had missed earnings?
The share price increase has been meteoric to say the least, as this chart off Google Finance shows:
Nobody cared about Tesla for ages, but suddenly it’s the hottest thing on the street.
If Tesla had made a loss in this quarter, it would’ve been cataclysmic for the share price. The company hit the target though, which means the next rebalancing of the S&P500 will in all likelihood welcome its newest member – Tesla.
Believing in perfection
Although I personally find the current valuation to be ridiculous, there’s no doubt that Tesla is showing positive momentum. The trouble is that things now get serious, because Musk’s company will need to hit its earnings targets every single quarter or the share price could unwind horribly.
It’s a very risky buy in my view.
Many people are happy to bet on perfection, but I’m not. I think the German war machines of BMW, Mercedes-Benz, Porsche and the like are going to give Tesla an enormous fright in markets outside of the US.
I’ve had the pleasure of sitting in a new Porsche Taycan. It’s a work of art. It’s a brilliant car that just happens to be battery powered, vs. a Tesla which is battery powered and just happens to be a car. Tesla works as a novelty, but the real fight is coming against the world’s finest automobile manufacturers.
Tesla is currently the most valuable automobile manufacturer in the world. Can that really be considered reasonable?
Can Tesla compete without regulatory support?
Reality check time.
In Q2 2019, automotive revenue was $5.4bn of which $111m was in “sales of regulatory credits” aka regulatory support for the move towards electric vehicles.
In Q2 2020, automotive revenue was $5.2bn of which a much higher $428m was thanks to regulatory credits. Do you see the problem here? Without these credits, the business isn’t that attractive.
It’s also worth mentioning that $48m of revenue is the recognition of “deferred revenue” due to the release of a new feature for the vehicles. No, I also don’t understand that. It sounds to me like exotic accounting under US accounting rules which conveniently coincides with a quarter where Tesla desperately needed to be profitable…
What about solar?
The “energy generation and storage” division generated $370m in revenue in Q2 2020, but cost of sales was $349m. Exciting technology, but barely profitable currently before even considering company overheads.
If you invest in Tesla, you need to believe in the electric vehicle story.
Welcome to the big league
Elon Musk is a larger-than-life character, whose personal brand has always been more valuable than his companies. This may be changing, but I would tread extremely carefully. I have some exposure to Tesla through index tracker funds that I’ve invested in, but I don’t hold Tesla shares directly.
Those who bought in this year have seen incredible returns, but they will disappear just as quickly if Tesla starts to battle with earnings again.
Perhaps before investing, do yourself a favour and check out the electric offerings of Porsche and Mini. Tesla won’t have it easy. In case you’re too lazy to check, here’s the magnificent Porsche:
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