{"id":66486,"date":"2020-11-17T11:04:15","date_gmt":"2020-11-17T16:04:15","guid":{"rendered":"https:\/\/ibkrcampus.com\/?p=66486"},"modified":"2023-02-10T13:33:34","modified_gmt":"2023-02-10T18:33:34","slug":"careful-what-you-wish-for-tesla-edition","status":"publish","type":"post","link":"https:\/\/www.interactivebrokers.com\/campus\/traders-insight\/securities\/stocks\/careful-what-you-wish-for-tesla-edition\/","title":{"rendered":"Careful What You Wish For \u2013 Tesla Edition"},"content":{"rendered":"\n

Frequent readers know that I have frequently referred to Tesla (TSLA) as a \u201cfaith-based\u201d stock because of its holders\u2019 near-religious zeal for the company, its products, and its shares.  The faithful have been rewarded throughout the company\u2019s existence, with the stock trading at astounding valuations.  The believers were reaffirmed once again yesterday afternoon, when S&P Dow Jones Indices announced that Tesla will be joining the S&P 500 Index (SPX) on December 21st<\/sup> as part of the index\u2019s quarterly rebalancing.  To steal a term from baseball terminology, it will be traded for a player to be named later \u2013 the company it is replacing has not yet been announced.<\/p>\n\n\n\n

This is big news, and it is quite understandable that TSLA shares are trading about 13% higher this morning.  Inclusion into SPX requires that the passive managers buy the shares in order for their holdings to properly replicate the index.  For a company the size of TSLA, that purchase requirement is staggering.  After today\u2019s rise, TSLA would enter the index as the 8th<\/sup> largest company in the index \u2013 after Berkshire Hathaway (BRK.B) and ahead of Johnson & Johnson (JNJ).  That would represent about 1.4% of the weight of SPX.  When one considers that there is over $12 trillion indexed to SPX, it implies that indexers will require about $170 billion worth of TSLA shares.  That is a huge amount, but remember that TSLA has added over $40 billion in market capitalization on today\u2019s move alone.<\/p>\n\n\n\n

Remember that rebalancing means that something must be sold in order to pay for something that is bought.  That is why the S&P index committee typically tries to find companies of similar sizes to replace one another when one is removed for a takeover or similar event.  If company A is being purchased for cash, indexers can simply use that case to buy shares of company B if it is similarly sized.  Yet there are simply no companies slated to leave the index that are as huge as TSLA.  That is why the index committee has given the markets over a month\u2019s notice to prepare for the news, and made the rare announcement that they would consider doing the addition as part of a two-step process.  This will be a very disruptive event for index investors, and potentially the markets as a whole.  The $170 billion for TSLA shares will need to come from somewhere, and that means that markets will need to accommodate that amount of selling in the other 499 shares in the index.<\/p>\n\n\n\n

So far I have seen many news stories fretting about where the indexers\u2019 TSLA shares will come from, considering true believers\u2019 reluctance to sell.  There are two obvious sources that one must consider \u2013 the company itself and Elon Musk.  One would have to expect that index addition would represent a buying climax, and thus a terrific opportunity for either the company or its largest holder to raise cash by selling into strength.  This is hardly an unprecedented idea.  I found the example of Mosaic (MOS), which had a holder sell about 30 million shares into that stock\u2019s index addition in 2011.  That proved to be an excellent sale.  I know there are other instances, but as of now I have not been able to find them. <\/p>\n\n\n\n

The ancillary effects of this announcement are numerous.  Others to consider are:<\/p>\n\n\n\n