One of the most common explanations for the frenzy of buying in Tesla in 2020 has been the stock’s eligibility for the S&P 500, which bulls say would force a tremendous amount of buying volume in the stock.
DataTrek Research co-founder Nicholas Colas on Monday said the case to include Tesla in the S&P 500 is far from cut and dry, and the impact it could have on the stock market may not necessarily be positive.
Tesla met the qualifications for inclusion in the S&P 500 for the first time when the company reported a profitable second quarter, bringing its trailing four-quarter GAAP net income into positive territory.
However, Colas said, the S&P eligibility commission may be troubled by the fact that Tesla reported $782 million in 100%-margin automotive regulatory credit sales in the second quarter compared with just $220 million in net income.
“This puts the S&P committee in charge of adding names to the 500 in a real bind, because while to the letter of their ‘law’ Tesla qualifies for inclusion this is purely due to regulatory arbitrage—not fundamental profitability from designing, manufacturing, and selling cars,” Colas said.
In fact, Colas said Tesla CEO Elon Musk’s commentary on Tesla’s second-quarter earnings call suggested even a relatively mild decline in demand could easily push Tesla back into negative net income territory.
At the same time, Tesla’s $382 billion market cap would make the stock the eighth largest company in the S&P 500, which could create its own set of problems for investors.
“We’ve read concerns this move could cause a temporary dip in the U.S. equity market as it resets the other 504 stocks in the ‘500’ to accommodate index funds’ need to sell them on rebalancing day,” Colas said.
He said the issues surrounding Tesla’s potential inclusion in the S&P 500 may highlight a need for Standard & Poors to reconsider its profitability requirements.
Including Tesla in the S&P 500 index with a $382 billion market cap after the stock has gained 850% in the past year would also add volatility to the market-cap-weighted index, potentially to the downside. Assuming Tesla is added, the stock would have the highest beta (a technical trading metric measuring volatility) of any S&P 500 stock with at least a $300 billion market cap.
This story originally appeared on Benzinga.
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