Tesla (NASDAQ: TSLA) stock will be included in the S&P 500 index from 21 December 2020, onwards. Since the news of the pending inclusion broke on 16 November 2020, Telsa’s share price has been electric. The day after the announcement, Tesla opened 12% higher. Its shares are worth 43% more now than they were before the news broke.
Commentators on the matter insist that there is more to come. On the day of inclusion, there will be a scramble for Tesla stock by funds that track the S&P 500 index, they say. So, buying Tesla now will allow an investor to sell higher once the additional, new demand from index funds hits the markets. Since the price of Tesla shares has rocketed before the S&P 500 inclusion date, it would be reasonable to assume that many have bought in anticipation.
The thesis is not outrageous at all. The stock markets are, after all, marketplaces. Market prices are determined by where supply and demand find balance. Tip the scales and the market price changes. In this case, since demand goes up, so must supply. But to entice more people to sell, a higher market price is settled upon. That price will persist, so long as demand does not fall.
S&P index inclusion
There is evidence that being included in the S&P 500 index does move a company’s share price. Research by McKinsey, a management consulting firm, found abnormal returns of around 7% on average up to the date of index inclusion. However, the effect disappeared 45 days after the inclusion date. In the long term, S&P 500 membership was not determined to bring any lasting share price premium for its members.
Should this result be surprising? I don’t think so. Index tracking funds have to buy the stock of new entrants, but once they are done, that’s pretty much it. The demand they bring to the table is short-lived. In fact, if enough investors buy the stock in anticipation of selling when the demand hits, then there could already be ample supply, enough even not to require a dramatic change in the market price.
Tesla is, of course, a little bit different. It will become one of the largest companies in the S&P 500. As such, the amount of dollars index funds spend buying Telsa shares will be hefty. There is a case to be made for the abnormal returns being abnormally large. But, I don’t believe there is a compelling case for them to persist.
We already know that inclusion in the S&P 500 index inclusion does not, on average, lead to any long-term price benefits for newly included stocks. For Tesla, beyond short-term increased demand, most of the other benefits of inclusion are already fulfilled. Tesla does not have a problem with investor awareness or access to capital markets.
The fact of the matter is that inclusion in the S&P 500 index does not change much at all about Tesla as a company. Short-term traders might be able to benefit from buying and selling Tesla stock around its S&P index inclusion date. However, for the long-term investor, stock returns are driven by the company’s performance and not index inclusion. Therefore, as it will not change my valuation of Tesla, I won’t be buying it just because of its S&P 500 inclusion.
James J. McCombie 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.