Tesla (NASDAQ:TSLA) shares have increased in value fivefold in 2020 but this week saw a particularly sharp rise.
The electric carmaker shot up more than 20% to hit its highest price since early October. So what exactly happened?
On Monday 16 November, Tesla announced that it would enter the S&P 500. This is a US stock index that includes 500 of the biggest companies in the country. Along with the Dow Jones, it is a major benchmark used to track how the US economy is performing. It remains one of the most popular ways to compare US stocks and shares.
At a market cap of $470bn, Tesla is more valuable than 99% of the companies currently listed on the S&P 500.
In fact, its inclusion would slot it into the top 10 most valuable companies on the index, above JP Morgan Chase, Johnson & Johnson, Walmart, Visa, and Mastercard.
Topping the list of the S&P 500 highest market cap companies are Apple, Microsoft and Amazon. Google parent company Alphabet, Facebook, and Warren Buffett’s Berkshire Hathaway round out the list.
Tesla’s second-largest investor, FTSE 100-listed Scottish Mortgage Investment Trust, cut its 7.6% stake to 4.25% recently. The flagship Bailie Gifford fund cited whopping valuations for Tesla shares as a reason to take profits.
Gaining entry to the S&P 500 is also a marker of respect. Just like being added to the FTSE 100, it exposes a company to far more liquidity than it would have otherwise. This means there are far more buyers and sellers for a particular stock.
The S&P 500 is weighted by valuation. So the bigger a company’s market cap, the greater proportion of the index it takes up. The minimum market cap to be added to the S&P 500 is just shy of $10bn.
This higher profile is not just limited to interest from smaller private investors.
Massive index mutual funds and exchange traded funds will also have to buy Tesla shares to accurately replicate the performance of the S&P 500. So it is reasonable to assume that demand for Tesla shares is likely to rise.
How Tesla shares made it
The gatekeepers of the S&P 500 demand that companies on the index must be profitable. Specifically, they require that a company must have been in profit in its most recent financial quarter and across the last financial year.
Profit was never part of Elon Musk’s early plans to build value into Tesla shares. The wily entrepreneur was laser-focused on using debt to capture market share as well as reinvesting cash to build his giant Gigafactory battery storage plants.
And Tesla has been heavily reliant on selling regulatory credits to other electric vehicle firms — rather than making margin on its cars — for its profits. Without these credits, Tesla would have made a loss in the first half of 2020. But better-than-expected third quarter results to the end of September 2020 showed Musk making a net income of $331m on revenues of $8.7bn.
Tesla shares will officially join the S&P 500 on Monday 21 December.
TomRodgers has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Tesla. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.