It's official – after many months of anticipation, controversy, and previous rejection from Standard & Poor's, Tesla will be joining the S&P 500 Index in December 2020. What are the pros and cons of adding the highly valued car company to the Index and what does it mean for investors?
CEO Elon Musk's electric vehicle (EV) and clean energy company stock is up nearly 550% over the last year, and now every S&P 500 Index ETF and mutual fund will be required to purchase shares of the stock. How much money will index funds be forced to invest into Tesla stock? Over $50 billion!
Tesla will be the most valuable company ever added to the most well-known index in the world. It is the most valuable car company in the world - currently worth over $420 billion and larger than 95% of the other S&P 500 companies. So let's discuss the criticism and excitement around Tesla's upcoming addition to the S&P 500 Index.
The Criticism
The skeptics say Tesla's current overvaluation is unfair to passive index investors who will be forced to buy the stock at inflated prices, now and in the future. Furthermore, when these announcements occur a month before the actual addition to the index, share prices surge in anticipation of future, ongoing index fund purchases. A surge in value for an already overpriced stock can lead to a bursting bubble for S&P 500 Index owners and drag other stocks down with it.
Since the S&P 500 Index is priced based on market capitalization, Tesla will be a top ten holding in the Index on day one due to its size. With that said, Tesla will still only make up roughly 1% of the index. So if skeptics are correct about Tesla's bubble bursting, it shouldn't wreak too much havoc on the diversified index. However, its potential influence on other stocks' momentum will be something to watch.
Actively managed investment funds that compete with the S&P 500 Index's performance will have to decide whether to buy Tesla or not. These investment portfolios hold trillions of dollars. If the managers decide to invest in Tesla, it will lead to even more purchases of the stock beyond the $50 billion that Index funds will need to buy. All this demand could push the stock price up, which many say is already overvalued.
The Excitement
Tesla is undoubtedly one of the most innovative automobile companies ever to exist. Many view Elon Musk, founder of SpaceX and Tesla, as our generation's greatest technological mind. It's hard to place a value on unprecedented future innovation.
Aside from Tesla and SpaceX, Elon is working on Neuralink, a project that could eradicate brain interruptions from known diseases like Parkinson's, ALS, and more. It even has the potential to eliminate anxiety and addiction. So why wouldn't we want the S&P 500 Index to invest alongside these types of innovative minds?
Tesla adds another level of diversification to the S&P 500 Index. It's not just a technology company or an automobile company. Tesla should also be categorized as a solar and clean energy company focused on fighting climate change. The addition shows the Index's willingness to grow and adapt to environmentally conscientious investments.
Summary
The addition of Tesla into the S&P 500 Index has been S&P's most controversial decision in recent history. This will be the largest company ever added to the Index. Skeptics believe the Index's investment decision is momentum-based and sets a poor precedent for future company selections. Others believe Tesla's innovation, environmental impact, and valuation is just getting started. Only time will tell how Tesla will influence other S&P stocks, but one thing is certain with their addition into the S&P…Tesla is here to stay!
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Please remember that past performance may not be indicative of future results. Prior to implementing any investment strategy referenced in this article, either directly or indirectly, please discuss with your investment advisor to determine its applicability. Any corresponding discussion with a Bedel Financial Consulting, Inc. associate pertaining to this article does not serve as personalized investment advice and should not be considered as such.
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