We were expecting some big moves from the Tesla Inc (NASDAQ: TSLA) share price overnight (our time), and Elon Musk's baby certainly did not disappoint.
The Tesla share price has risen by 8.21% to US$441.61 a share. Tesla closed at US$408.09 on Monday (US time), but opened at US$460.17 on Tuesday (up 12.8%) before sliding over the course of the trading day to US$441.61. On this price, Tesla shares are up 413% year to date.
So why were we expecting a big move from this electric vehicle and battery manufacturer?
Well, yesterday investors received the news that Tesla is finally set to join the S&P 500 Index on 21 December, after months of speculation.
Why is the S&P 500 so important?
The S&P 500 is one of the most tracked indexes in the world (if not the most tracked). It represents 500 of the largest public companies in the US.
But you might be wondering why Tesla isn't already a part of the S&P 500 – especially given its market capitalisation is currently more than US$400 billion, and has been above US$300 billion for months now.
Well, in contrast to other indexes like the S&P/ASX 200 Index (ASX: XJO), entry to the S&P 500 is not based on market cap alone. According to our Fool colleagues in the US, entrants are required to be approved by a committee run by S&P Global Inc (NYSE: SPGI), the company behind the index (as well as the ASX 200). That's why Tesla has been present in exchange-traded funds (ETFs) tracking non-S&P 500 indices, like the Vanguard US Total Markets Shares Index ETF (ASX: VTS), but not in S&P 500 ETFs like the iShares S&P 500 ETF (ASX: IVV).
Additionally, approval for S&P 500 entry is also subject to meeting certain criteria, such as a trading volume threshold and 4 consecutive quarters of profitability. Tesla achieved this last milestone back in July, and as a result was expected to be admitted into the S&P 500 back in September, which did not eventuate.
Why does index inclusion result in a higher Tesla share price?
If a stock is added to an index, it means that all ETFs, managed funds and other investment vehicles that track the index are compelled to buy it. And because the S&P 500 is one of the most-tracked indexes in the world, any new entrants will have an army of investors and funds clamouring to buy the stock.
What's more, Tesla is a massive company, and will thus be commanding a large presence in the index from the start (unlike most new S&P 500 entrants that get slotted in at the back end). Assuming Tesla's current share price, it looks as though it will be approximately the 11th stock in the index by market capitalisation and be given a weighting of roughly 1.19%. If a stock joined the index from the back end, it would be looking at a weighting of something like 0.01%.
That's a lot of buying pressure that's going to be flowing into the Tesla share price when the company is admitted into the index on 21 December. Last night's share price appreciation is likely the result of some investors jumping the gun with excitement and anticipation.
