Tesla officially joins S&P 500 index: So what?

Electric automaker Tesla Inc (NASDAQ: TSLA) was officially welcomed to the prestigious S&P 500 index last week and its inclusion was certainly an unusual case study.

How Tesla fits in

Tesla is among the largest companies in the world and this created a series of challenges on how a $600 billion company can be added to the S&P 500 index. The company has seen its valuation skyrocket by more than 700% in 2020 which makes it the largest company to join the index. 

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Never before has the index managers had to figure out how to balance the portfolio to make way for a new issue that accounts for 1.69% of the index.

Tesla’s size is even large enough to change the dividend yield of the index. Since the company doesn’t offer investors a dividend, the S&P 500’s dividend yield falls by default of its inclusion from 1.56% to 1.53%, Senior Index Analyst at S&P Dow Jones Indices told CNBC.

But on the other hand, Tesla’s large size means it could have an outsized influence on the index’s move, he said. Specifically, an $11.11 per share move in Tesla’s stock translates to a one-point change in the index.

Goldman Sachs analysts previously estimated that if Tesla was included in the index as of the start of January, the S&P 500 would be a full 2 percentage points higher. This means that instead of the index is up 13% for 2020, it would be up 15%.

Tesla is an expensive stock

Tesla also ranks as one of the more expensive stocks in the S&P 500 index, according to CNBC. The stock is trading at 186 times forward earnings yet surprisingly its impact on the index’s valuation doesn’t change much.

According to Silverblatt, the S&P 500’s 2021 price to earnings ratio moves higher from 22.3 to just 22.6 by default of Tesla’s inclusion.

Do we know what’s next for Tesla’s stock?

By default of Tesla’s inclusion in the index, passive and active fund managers were rushing to buy the stock in the days leading up to its inclusion. This explains why the stock was higher by nearly 6% on Friday and closed at an all-time high of $695 a share.

Volume on Friday was four-times larger than the 30-day average trading volume, according to CNBC.

But now that the stock is a component member, the debate about the company’s long-term prospects will continue. Those who believe Tesla’s stock is overvalued will continue betting against the stock. The bulls will continue to argue that Tesla’s growth profile can drastically expand over the many decades ahead.