Tesla's upcoming S&P 500 inclusion won't make the index as expensive as some expect, Goldman Sachs says
- Tesla's December 21 inclusion into the S&P 500 won't have the massive impact some investors are expecting, Goldman Sachs said.
- The automaker's lofty multiple and $600 billion market cap led many investors to believe its addition will push the S&P 500's price-to-earnings multiple as much as two multiple turns higher, according to the bank's strategists.
- Instead, nuanced calculations used to determine the index's price suggest its multiple will only rise by 0.4 multiple turns, they added.
- Goldman still expects Tesla's inclusion to have a meaningful impact on the benchmark's performance. The strategists determined that, had the automaker been included in the S&P 500 all year, it's 2020 rally would've lifted index returns by two percentage points.
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Tesla joining the S&P 500 will make smaller waves than some investors are preparing for, Goldman Sachs strategists said in a Wednesday note.
The automaker currently trades at an extraordinary 170 times its projected 2021 earnings after soaring roughly 680% year-to-date. Tesla's $600 billion market cap signals it will join the benchmark index on December 21 as one of its most highly valued members and a weight of about 1.5%.
Many investors have inferred that Tesla's lofty multiple and hefty market cap will drive the S&P 500's valuation markedly higher, but strategists led by David Kostin expect the company's inclusion has far less influence. Where some expect the index's price-to-earnings multiple of 22 to climb by two multiple turns or more, Goldman expects the ratio to rise just 0.4 multiple turns.
The disparity has everything to do with the nuances of index calculations, according to the team. While S&P 500 members are weighted according to their free-float market caps, conventional metrics treat the benchmark as an aggregate of its individual members instead of a cap-weighted average.
For example, the index's EPS is calculated by taking the earnings of all 500 members and scaling them down from about $1 trillion to a "more manageable per-share number," the bank said. Both market cap and earnings for each member are adjusted in proportion to their free float.
In the end, the index's P/E ratio is an earnings-weighted average, as opposed to a market-cap-weighted one. So while Tesla will count for about 1.5% of the S&P 500, its earnings will represent just 0.2% of the index's total, the strategists said.
Still, Tesla's inclusion will have a sizeable impact on the S&P 500's performance after December 21. Shares have outperformed the benchmark by 640 percentage points in 2020, and had it been a part of the index all year, it would've lifted total returns by two percentage points, according to Goldman.
The automaker's addition will also have a "small mechanical impact" on the index's overall volatility and the S&P 500-linked VIX, the strategists added.
Tesla finished Thursday at $655.90 per share, up 5.3% for the day.
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