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While most of us are counting down the days until 2021, one man who’s probably hoping this year never ends is Elon Musk. The chief executive of Tesla, the electric car company, has watched his firm’s share price rocket since January, launched the first private space craft to take humans into orbit, become the world’s second richest man, and welcomed the birth of his daughter, X Æ A-Xii.
To top off a stellar year for Tesla, the company is set this month to join the S&P 500, the index of America’s 500 largest companies. Much like the FTSE 100, constituents of the S&P 500 are reviewed on a quarterly basis, at which point smaller stocks may fall out and rising ones take their place.
If size were the sole criterion for entry, Tesla would have joined a long time ago - by market capitalisation, Tesla is the 7th biggest company in the US. However, the company was long debarred because of its failure to deliver four consecutive quarters of profit.
Even when a fourth consecutively quarterly profit posted in June meant that Tesla finally met the requirement, it was still spurned entry during September’s reshuffle.
Ultimately, entry to the index is not guaranteed by meeting formal requirements alone but rests on the verdict of a committee. It’s unclear precisely why Tesla didn’t make the cut last time around. One theory is that a source of its profits through the sale of regulatory credits - credits which Tesla earns by making electric cars and then sells on to other companies that do not meet regulatory requirements - may have played a part. Either way, Elon Musk will be happy to see his firm finally recognised.
Investors certainly were. On the day of the announcement, Tesla’s share price shot up 13% in after-market trading, with its value surging past $500 billion as a result. Please remember past performance is not a reliable indicator of future returns.
But such exuberance poses problems. When Tesla joins the index later this month, the vast number of passive funds that track the index will rush to include the company in their portfolios, as will many active funds that use it as their benchmark.
Normally, when a company joins the index, the upsurge in trading into these funds causes minimal disruption because of the entrant’s relatively low value. Tesla’s entry, however, will be the biggest on record. It will instantly become one of the most valuable companies on the index. As such, it’s expected to trigger up to $70 billion of passive fund flows alone. That could lead to further volatility across the index as a whole.
To dampen its impact, S&P had been considering introducing Tesla in two instalments but has since decided to stick to just one big swoop.
This certainly isn’t the first time this year that Tesla’s size has left investors and traders scratching their heads. In a year of quite remarkable market movements, Tesla’s story stands out.
As one of the handful of technology stocks that have buoyed markets and left flailing cyclicals in the dust, its rise has defied gravity and flummoxed investors. The flamboyance of its “larger-than-life” executive has garnered further attention to the stock’s success.
The worry will be that Tesla’s success will last only as a testament to 2020’s weirdness - that, once we get back to normal, so will the company’s share price. But Tesla’s sky-high valuation is not just market bravado. Musk has tapped into several trends - the rise of climate-conscious solutions being one - which set his company apart from the competition.
It will certainly be interesting to see what happens over the course of 2021.
Five year performance
Past performance is not a reliable indicator of future returns
Source: Refinitiv, total returns as at 30.11.20, in USD terms
Important information: Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Overseas investments will be affected by movements in currency exchange rates. When you are thinking about investing in shares, it’s generally a good idea to consider holding them alongside other investments in a diversified portfolio of assets. Investors should note that the views expressed may no longer be current and may have already been acted upon. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.
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