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.

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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.

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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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