CryptocurrencyInvestingBanksReal Estate

Tesla shares pop after a big earnings beat—but its jump to the S&P 500 is hardly a ‘sure thing’

October 22, 2020, 4:43 PM UTC

Investors have seemingly breathed a sigh of relief after Tesla continued its profitability streak, as the Elon Musk–led company beat earnings estimates late Wednesday.

Tesla stock traded up 2.2% in early afternoon trading on Thursday as the company reported $8.8 billion in revenues for the third quarter, and, most notably, $331 million in profits—the company’s fifth straight quarter in the black.

Investors continue to zero in on Tesla’s profitability, ever-bullish Dan Ives of Wedbush Securities argues. “Overall, they checked a lot of boxes in terms of profitability—the 500,000 units [goal] for the year guidance and also giving investors comfort [around] the factory buildout between Berlin and Austin,” Ives tells Fortune.

Ives recently raised his price target for the stock to $500 per share, and raised his bull case to $800 (up from $700) on Thursday. So far this year, Tesla’s stock has shot up over 405%, and the company performed a 5-for-1 stock split in August.

Credits concern

One sticking point worrying some on the Street is the portion of revenues Tesla derives through the sale of emissions credits. Electric-vehicle makers can take in a tidy profit selling their emissions credits to rivals whose fleet consists mainly of gas-guzzling, carbon-spewing automobiles. As emissions controls have tightened in places like Europe and California, the credits sales have gone up, reaping high-margin revenue for the likes of Tesla.

In the third quarter, revenue from the sale of those credits hit $379 million. That was down from $428 in the prior quarter, but just enough to help the EV maker turn a profit this quarter. That “regulatory credits” line item is going to be a key area of focus for Tesla investors moving forward as that lucrative line of business is expected to shrink in the coming quarters.  

To be sure, those credits will remain a key part of the business, but Ives believes with profitability from the core auto business beating Street estimates, “the baton starts to get handed [from the credits] to the core business from a profitability perspective over the next 12 to 18 months,” and he estimates the underlying profitability of the company could ramp up “toward the mid-20s on a gross margin over the next few years.”

Is S&P to be?

A big dampener on the stock in recent months has been its failure to win inclusion in the S&P 500—a move some analysts like Morningstar’s David Whiston argued was due to those concerns over its profitability record. But those worries might not last forever, JMP Securities’ Joseph Osha recently told Fortune; he believes “the concerns about profitability are going to evaporate, and the people who make these index decisions will do what they do.”

With a fifth straight quarter of profits on the EV maker’s books, Tesla could be positioned for inclusion imminently.

“Possible inclusion to the S&P 500 index remains a catalyst to the stock,” Morningstar’s Whiston wrote in a note Thursday, as he also raised his “fair value” estimate for Tesla to $319 per share from $195 (still about a 24% haircut from the stock’s current levels). “But we do not think it’s a sure thing due to credit sales and Tesla’s small profits for a company with its large market capitalization.”

As to where the stock goes from here, even bullish Ives believes it may trade flat to slightly higher in the coming months as investors await fourth-quarter delivery numbers. But he notes that “for a stock that’s up 400%-plus this year, there’s a lot of good news baked in.”

More must-read finance coverage from Fortune: