I think it’s fair to say that market participants are obsessed with Tesla index inclusion.
The term “obsessed” doesn’t always have to be pejorative, and I’m not (necessarily) using it in a pejorative way here. All I’m suggesting is that investors (as distinct from traders and speculators) should consider whether their own level of concern over this admittedly historic addition is being driven more by the media frenzy than it is by any rational analysis about the possible implications for long-run portfolio returns.
Put differently, if you’ve read more than two or three articles about Tesla inclusion in the past week, you might consider asking yourself if your level of interest is really commensurate with the prospective impact of inclusion or whether you’ve simply been swept away by the media which, at the end of the day, aims not to inform, but to sensationalize.
Of course, discerning whether your level of concern is “appropriate” can be difficult, which is why I thought is was worth highlighting some key points from a new Goldman note that takes a look at the expected impact of Tesla in the S&P.
“Tesla currently trades at 170 times consensus 2021 earnings with a $600 billion market cap and $480 billion float cap,” the bank’s David Kostin wrote, noting that “given Tesla’s large size and elevated multiple, many investors erroneously intuit that the company’s inclusion into the S&P 500 will lift the index’s current 22x P/E multiple – which already registers close to the highest levels on record – by two multiple turns or more.”
According to Kostin, that “intuition” isn’t even close to accurate. Rather, Tesla’s inclusion would only push the S&P’s multiple higher by 0.4 turns.
That’s “not nothin’,” as they say, but at the risk of trivializing the situation, it’s not material for the average investor. If you’re already terrified of US equities at 22x (FY2), you’re not going to be more terrified at 22.4x, and if you’re already a buyer up here, less than half a multiple turn surely isn’t going to deter you.
“[Tesla] will augment the index market cap by roughly 1.5% with only a de minimis contribution to index earnings,” Kostin reminded investors. “As a result, the inclusion will lift the aggregate index P/E multiple by slightly less than 1.5%, or less than half of a P/E multiple turn,” he added, before noting that “this impact would be similar whether the stock traded at a P/E multiple of 170x, 500x, or 1000x.”
Obviously, if you use a market cap-weighted multiple, the impact is more dramatic. Specifically, Goldman says Tesla’s inclusion will increase the cap-weighted multiple by a couple of full turns.
But even there, I’m not sure it makes much difference at this point. The cap-weighted P/E is already 29x (give or take). If you’re inexplicably comfortable with that, are you really less comfortable at 31x? I doubt it.
In fact, if you’re the type of investor who’s buying voraciously when multiples (both for the aggregate P/E and the cap-weighted P/E) are 96th%ile and above, your risk tolerance is almost by definition higher than average, and it will likely take more than an uptick in traditional valuation metrics to deter you. The figure (below) underscores the point.
Do you know anyone who’s buying at the pre-inclusion valuations (dark blue) who wouldn’t be buying at the post-inclusion valuations (light blue)? I don’t.
The bottom line when it comes to equities trading at (or near) the richest levels in history is that you’re either buying (figuratively and literally) the notion that these multiples are acceptable based on where bond yields are, or you aren’t buying it. That debate — the relative valuation discussion — is a hot topic right now, and forgive me, but I don’t think Tesla makes a damn bit of difference when it comes to resolving it.
Consensus is looking for $169 in 2021 EPS for the S&P. Tesla’s addition should mechanically reduce that to around $167. Again, I can’t see how that’s going to win any “hearts and minds” either way.
“Tesla’s inclusion could also have a meaningful impact on index performance,” Goldman’s Kostin went on to say. “TSLA has risen by 657% this year, outperforming the S&P 500 by 640 pp,” he added. S&P 500 returns would have been 18% this year versus 16% had it been in the index for the duration of 2020.