This week, S&P Dow Jones Indices announced that Tesla (TSLA) would join its S&P 500, the most important stock market index that tracks 500 American large-cap companies. The company will join the index on December 21.
The electric car maker’s inclusion means that all of the index funds and ETFs that track the index will have to own it, which is why the stock jumped on the news.
But getting into the index has not been easy for Tesla, which up until recently met much of the criteria for getting in. A company must be big enough to merit inclusion (over $8.2 billion in market capitalization), be profitable enough (four consecutive quarters of profit), have enough shares to float, and meet certain corporate governance criteria — though some companies have been grandfathered in and have multiple share classes, like Google’s GOOG and GOOGL.
Tesla met those criteria in July and has been an enormous company for a long time. Its market cap is over $421 billion. So why wasn’t it included before? S&P is notoriously tight-lipped about how these decisions are made, but recently the legendary chair of the committee, David Blitzer, opened up to Bloomberg about stocks like Tesla.
Blitzer, who is now retired and wasn’t involved in discussions after he left, essentially told investors to be patient..
Blitzer, who told Bloomberg in October that he expected Tesla to get added, said the index was supposed to be "a great measure of the market," rather than something formulaic. In other words, if a company isn’t in the S&P 500 index, the committee has its reasons to believe including it wouldn’t result in the index representing the market to its standards.
“There’s plenty of times when there’s big names, popular names, well-known names that don’t get added the moment they’re eligible,” Blitzer told Bloomberg. “I think the real question is, why the rush?”
The interview highlighted an important part of Tesla’s stock performance that worked against it: its meteoric rise. The wait-and-see attitude was precisely because a quick boom might just as easily reverse, and being the “great measure” means that there’s pressure on the index to make sure shooting stars don’t get included.
This has implications for future companies and investors alike. The human component can’t be discounted from the committee, which may value steadiness more than investors — which, as part of financial Twitter speculated recently, may be why Tesla as well as Zoom (ZM) weren’t included. This is what Credit Suisse recently speculated in a note.
Some might think – incorrectly – that S&P methodology for index inclusion is based solely on meeting specific quantifiable benchmarks. But human decision-making – with its nuances and biases – are part of the process sometimes as well.
There’s no doubt that this human “active management” part is a bit odd. As DataTrek’s Nicholas Colas put it in a note on Tuesday, the S&P 500’s result is passive, but the stock picking is completely active. “If there were ever a time for the S&P committee to revamp its index inclusion criteria, it is right now,” Colas wrote.