Will Tesla be added to the S&P 500? Here’s how it will be decided
A major driver of Tesla’s recent run is rampant speculation that the company will be added to the S&P 500—the blue-chip U.S. stock market index—following its earnings report next week on July 22. The bulls’ thinking goes that Tesla’s inclusion in the S&P 500 would automatically force all sorts of passive investors—such as exchange-traded funds (ETFs) and other index-tracking funds—to buy Tesla stock, boosting the shares further.
The investment thesis is generally valid. History shows that stocks have risen after their addition to the S&P 500: When Amazon was inducted into the index in 2005, its shares rose nearly 5% on the announcement. Many of the investors who bought Tesla on Monday—nearly 50,000 on the investing app Robinhood alone, according to analytics site Robintrack—are likely looking to own the stock before it’s added in order to catch that potential windfall.
Yet despite the hype, Tesla’s addition to the S&P 500 is far from assured. Here’s what it would take and how likely it is to happen—and when.
Will Tesla join the S&P 500?
Besides market valuation and trading liquidity requirements—which Tesla, with a market cap of more than $277 billion and more shares traded in a day than what’s required in a month, easily meets—the last remaining criterion for the S&P 500 is profits.
To be included in the S&P 500, not only must a company have netted a (GAAP) profit over the past four quarters combined, it must also record positive net income for the most recent quarter. That means, while the electric vehicle maker has reported a profit for the past three quarters in a row, according to the rules, Tesla must also post a profit for the second quarter of 2020, when it reports those financial results next week.
Wall Street, however, does not expect this to happen. Analysts estimate that Tesla will report a loss of more than $377 million for the quarter ended June, according to Bloomberg data.
Still, the consensus view has not stopped some from predicting that Tesla will be added to the S&P 500 anyway, even if it does not meet the official criteria. In a note published Tuesday by Bloomberg Intelligence analysts, the authors write that Tesla’s inclusion in the index “may require human intervention,” and that they expect the committee that oversees the S&P 500 “to make an exception and add the automaker anyway.”
The analysts reason that the S&P 500’s recent underperformance—it’s down about 1% year to date while the Nasdaq has risen some 17%—is due in part to its lack of high-flying stocks like Tesla and Zoom. Tesla stock has rocketed about 266% so far in 2020, making it one of the year’s best-performing stocks.
Bloomberg Intelligence also points to a fine-print specification in S&P Dow Jones Indices’ official documents, that its committee “reserve[s] the right to make exceptions when applying the methodology if the need arises.” Such discretion, the analysts argue, “is an acknowledgement that index rules occasionally need to be overridden.”
It’s unclear, though, if the S&P 500’s committee has ever actually bent its own rules. “I’m unaware offhand of any examples where we added a company whose most recent earnings quarter was not positive,” Ray McConville, a spokesperson for S&P Dow Jones Indices, tells Fortune.
Investors buying Tesla now on the assumption that it will be added to the S&P 500 should be aware they are taking a leap of faith.
When would Tesla be added to the S&P 500?
If the index’s committee did decide to add Tesla to the S&P 500, it would not happen immediately when the electric car maker reports earnings next Wednesday after the market close.
Changes to the S&P 500 aren’t made based on when a company gains or loses eligibility, but rather whenever the index’s committee “deems necessary,” according to McConville, the spokesperson for S&P Dow Jones Indices.
“All that’s to say that there’s no future date on the calendar when the next changes will be made,” he says.
The S&P 500’s committee does meet monthly, and could potentially make changes to the index’s constituents then, but the firm could not confirm by press time when the next meeting would take place; it also rebalances the index each quarter, and could swap companies in and out then, but that’s not scheduled to happen until Sept. 21.
In the past, when S&P Dow Jones Indices has added companies to the S&P 500, it announces the changes four to 10 days ahead of when they actually take effect—which is always before the market opens for trading.
Of course, investors looking to get the biggest pop on their investment will want to buy the stock before the official announcement.