A sharp-eyed client who knows our penchant for oddball indicators wrote us today with a suggestion: type “Should I” into Google and see what autocompletes the search engine suggests. The algorithms pop up the most likely completion of a query based on what other users have searched for, so it is a good sentiment indicator.
The top Google autocomplete: “Should I buy Tesla stock”, followed by the legendary song from The Clash “Should I stay or should I go?” One would call that a matched set. When a stock gets so popular that even Google knows everyone is interested, it’s more likely time to “go” than “stay.”
More broadly, we see the lesson of TSLA’s remarkable climb of late through one lens: it is not in the S&P 500. Here’s why this high flier, with a $160 billion market cap today, is not in the most-watched US stock market index:
- In order for the S&P committee to consider a stock for inclusion, the sum of its trailing 4 quarters of reported GAAP earnings must be positive, as well as the most recently reported quarter.
- Tesla’s trailing 4 quarters of GAAP earnings are negative to the tune of $862 million (see link to the company’s summary below).
- Q3 and Q4 2019 GAAP earnings were positive ($248 million combined), but Q2 2019 showed a loss of $408 million. That means Tesla would need to post a Q1 2020 profit of $161 million or greater to hit the S&P committee’s requirements.
The bottom line here is that according to analysts’ estimates TSLA should make enough money in Q1 2020 to satisfy the trailing 4-quarter/current profitability rules. A lot could still go wrong; this is not a company with a predictable earnings stream. And the S&P committee would have to make the final decision, of course. But TSLA meets all the other requirements, from a US domicile, to a 1-class stock, liquidity and seasoning (not a recent IPO).
Here’s the rub though: even if the stock pulls 50% back from its current mania – the same sort of drop it experienced from late 2018 to May 2019 – it will still be an $80 billion company by market cap when the S&P committee considers it for inclusion. That puts it in the same realm as the combined value of GM ($49 billion) and Ford ($36 billion). Not cheap, in other words.
All this highlights an underappreciated problem with the growth of passive investing. The S&P 500 is the single most popular large cap index; 3 of the 5 largest US-listed exchange traded funds track it, and they collectively have 27% of all US equity assets under management in ETFs. And while there are some active ETFs with large slugs of TSLA in the portfolio, if you want a passive index fund with a +5% weighting in Tesla your options are limited and in small funds.
The bottom line here: index based investing, especially tied to S&P criteria, misses important disruptive companies while hanging on for dear life to the disrupted. Despite TSLA’s unquestioned popularity, only 4.2% of its float sits in ETFs, versus 7.3% for GM and 8.2% for Ford. It’s easy to make a case for why it should be the other way around, even if TSLA’s valuation were actually reasonable rather than stratospheric.
S&P Rules for Inclusion: https://us.spindices.com/documents/methodologies/methodology-sp-us-indices.pdf