Christmas is coming early for Elon Musk, as it has been announced that Tesla, Inc. (TSLA) will be joining the S&P 500 on Dec. 21. This is a significant moment for the company, and it is being spun as both a validation of Musk's technology and recognition that electric vehicles (EVs) will be the future. We'll look at what this could mean for current and future Tesla investors.
- The S&P 500 has announced that Tesla will be joining the index.
- Tesla has had a strong 2020, posting five profitable quarters in a row and maintaining a pace to sell 500,000 vehicles this year.
- However, the company's valuation has gone beyond rich into an area rarely touched by tech stocks, let alone automakers.
The Significance of Joining the S&P
Inclusion in an index isn't just about prestige – there is a palpable market reaction that comes with it. Tesla stock is up roughly 19% on the news, and there is a further anticipation of buying once all the index-tracking funds update their S&P holdings. This is positive news for Tesla investors and perhaps a sign that the company is finally transitioning to be a more traditional automaker in the sense that it is going to make money selling cars rather than regulatory credits (although credits still play a role in the profits).
To get to this point, Tesla had to post four quarters of profits, a criteria introduced by the S&P selection committee following the inclusion of Yahoo Inc. in December 1999, just before the internet bubble burst. Tesla has managed five before inclusion, perhaps signaling a reluctance on the part of the S&P committee. More than a few market pundits have pointed to the worrying symmetry between Yahoo's and Telsa's entries into the S&P.
Tesla's Unreal Valuation
Tesla is a tech company for all intents and purposes, despite being an automaker. Tesla currently trades at a trailing P/E ratio of over 900 and forward P/E ratio of over 120. Even with newfound profitability, the market has run Tesla up an incredible amount. The company has a market cap of $460 billion – more than several of the world's three largest car makers combined.
This is hard to credit, as Tesla has yet to sell 500,000 vehicles in a year, although it is on pace to hit that mark this year. Toyota Motor Corporation (TM), for example, sold over 830,000 Toyota vehicles in September (in what will be a down year) and will probably sell more of its Daihatsu sub-line of vehicles this year than Musk sells Teslas. Toyota trades at P/E ratio of 14 and has a market cap of under $200 billion.
We can talk about the Toyota-to-Tesla comparison being apples-to-oranges given Tesla's tech company valuation, but that doesn't remove the question of how Tesla the company will ever catch up to Tesla the stock. This is even worse because a whole bunch of passive investors are going to be grabbing on to this rocket whether they want to or not through exchange-traded funds (ETFs) tracking the S&P 500.
Moreover, the market is acting like Tesla has sole control over an electric automotive future. That may have been true in the past, and the company may have the edge in battery technology, but all the other global car makers have EVs planned or already on the market, and they are rapidly iterating to catch up. Given their large, well-developed supply and sales networks, it is hard to imagine that the established automakers will remain way behind forever. (For more, check out 6 Biggest Risks of Investing in Tesla Stock.)
The Bottom Line
There are a lot of great things to say about Tesla, from its inclusion as the largest ever new S&P 500 member to the vision of Musk to move the needle on EVs as a transportation mode for a less emissions-intense future. It would be easier to focus on these things if Tesla weren't burning through the stratosphere of what a reasonable valuation for an innovative, mid-sized automaker should be. No matter how much faith you put in Musk, it is difficult to see how Tesla will live up to its valuation in the near, medium, or even long term.