If you have an S&P 500 index fund in your portfolio, you won’t have any choice in the matter.
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A lot of people have strong feelings about electric vehicle pioneer Tesla Inc (NASDAQ: TSLA), both as a company and as an investment. The Elon Musk-led company has generated plenty of controversy over its history, but its skyrocketing share price has left its automaker peers in the dust.
The stock’s amazing run has delivered 550% returns in just the past year, and more than 9,500% gains in Tesla’s roughly 10 years as a publicly traded company. That has resulted in a share price that many investors think is far too high to pay.
Yet even if you believe that Tesla isn’t a buy right now, you might still end up acquiring some of its stock soon. That’s because the company that manages one of the most-followed stock indexes in the world just decided to add Tesla to it.
Tesla is joining the S&P 500
S&P Dow Jones Indices is the entity behind the S&P 500 Index (INDEXSP: .INX). The popular benchmark contains roughly 500 of the largest and most influential US companies, but its membership is not static. S&P Dow Jones often adds new components and removes old ones to reflect changing factors like market capitalisation, takeover activity, and other corporate events.
For a long time, Tesla wasn’t eligible to be in the S&P 500 despite its large market cap. Many of the formal requirements for inclusion, such as a minimum share price and adequate share float, weren’t a problem for the electric automaker. The requirement that it took the longest for Tesla to meet was that it had to be profitable for four consecutive quarters and over a 12-month period.
Yet even when that happened earlier in 2020, S&P Dow Jones didn’t immediately pull the trigger. Some pundits cited issues with the quality of Tesla’s profits, boosted as they are by regulatory credits. Others pointed to the complexity of adding a company to the S&P 500 that was already as large as Tesla was.
S&P Dow Jones ended the speculation on Monday when it said it would add Tesla to the S&P 500, effective 21 December.
A couple of unusual things about Tesla’s addition to the S&P 500
However, the announcement wasn’t typical in a couple of respects. First, S&P Dow Jones didn’t announce which company Tesla will replace. It’s putting that decision off until we’re closer to the late-December rebalance date.
Also, S&P Dow Jones reached out to the investment community for guidance on precisely how to add Tesla. Given the company’s size – its market cap is above $420 billion – this move has the potential to cause a massive disruption to index-related trading. The index manager suggested the possibility of adding Tesla incrementally, possibly incorporating two separate dates on which portions of the final allocation would get put in the S&P 500.
You would’ve been better off buying earlier
The irony here is that index-fund investors who scoffed at buying Tesla earlier in 2020 are going to end up paying much higher prices for the shares. At the beginning of the year, you could’ve bought Tesla shares at a split-adjusted price of less than $100. As recently as June, Tesla stock was trading under $200 per share. But on Monday, Tesla closed above $400 per share – and it jumped more than $50 per share on the S&P 500 news.
However, index funds have no choice. If they want to track the S&P 500, they will need to own Tesla shares – regardless of the premium they’ll be paying to acquire them.
It’s not the end of the world
This isn’t the first time investors have had to accept index-fund additions they didn’t like. It happened with Facebook (NASDAQ: FB), but in hindsight, index investors have to be pleased with the returns the social media giant has generated for their funds.
Moreover, even at Tesla’s massive current size, its impact on your S&P 500 index fund won’t be all that big. Tesla will likely end up with a weighting of slightly over 1% in most of those funds. That will make it the biggest new addition ever – but it still doesn’t amount to a huge exposure to the automaker’s stock.
Tesla will continue to generate controversy, and it’s highly possible that the S&P addition will be the next event that triggers a massive feeding frenzy for the electric vehicle pioneer’s shares. In the end, though, what will matter is whether Tesla can convert on its amazing potential and expand into a business that justifies its industry-leading valuation.
Where to invest $1,000 right now
*Returns as of June 30th
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Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool’s board of directors. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. owns shares of and recommends Facebook and Tesla. Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool Australia has recommended Facebook. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.
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