Tesla Wobbles as it Finally Gets Admitted to S&P 500

Tesla

Being the sixth most valued company by the stock market should definitely qualify as being in the big 500. Tesla simply grew so large that this big gorilla could not be ignored anymore.

Like all stock exchanges, the benchmark S&P 500 collection of the country’s large cap stocks does change its collection from time to time. Often, companies no longer measure up, and a stock on the way up replaces it instead. The differences between the incoming and outgoing company in the index are always substantial, but this one is simply epic.

Apartment Investment and Management (AIV) is now gone, a stock that is not only down 26% in 2020 so far, and given the damage that this industry has suffered, with so many unable to make their rent payments this year, this is not surprising. This is not a hot stock that has fallen under tough times just this year though, as they are also down by 16% over the last 5 years, and therefore looks like an excellent choice to cut even if replaced by a random stock, one that perhaps has just kept up with the big index.

The S&P 500 has had a good year even not accounting for the economic devastation that 2020 has brought. Predictions were for low single digit gains at the start of the year, yet the index has gained 15% so far this year, in the face of some pretty dire happenings in the economy. Losing 26% instead just doesn’t cut the mustard, and having your outlook pretty dim going forward with a stock that has done so poorly for so long definitely sealed the fate of this turkey.

In spite of this change, the S&P 500 is definitely on the crusty side compared to its much more hip sister index, the Nasdaq 100, and the Nasdaq has been soundly beating the S&P 500 for a very long time now. This has carried over to 2020, with the Nasdaq 100 soundly beating the big index by 45% to 15%, with the year almost over. The Nasdaq is simply more forward looking, with the S&P 500 much more backward looking, and this continues to play out in their results.

Tesla has been on the Nasdaq since its shares first hit the market 10 years ago, on June 29, 2010, over 10 years before it finally got added to the S&P 500 on Monday. The Nasdaq saw Tesla’s potential from the start, while the S&P waited until it grew into the sixth biggest stock in the market to finally make the call.

Tesla opened up at $3.80 per share all those years ago, and it had to break the $600 per share mark for the big index to finally add it. Part of the reason why the two indexes have diverged in performance, with the Nasdaq continuing to thump the S&P 500, has to do with their attitude, with the Nasdaq looking toward companies whose futures are bright, and the S&P 500 giving a lot of weight to stocks that may have been decent at one time but whose future prospects may be far less bright.

Apartment Investment and Management did take a hit this year, but this is not a company that people would have thought of as one that had all that exciting of a future, and this has been reflecting in their stock price for a lot longer than just this year. The S&P doesn’t really understand stocks that well though, a statement that many may find surprising, and the main reason behind this misunderstanding is their preoccupation with looking at the past and the present and paying far less heed to the future than they should.

The stock market actually only cares about the future, they don’t care about how a company may have done 5 or 10 years ago or even how they may be doing right now. It’s all about where a stock may be headed. Tesla spent most of its decade on the stock market as a company that did nothing but run further and further in the hole, but always had the potential to be a profitable company once they developed their business enough, and that day did indeed come.

When people buy a stock, they know what the market values it at today, and this calculation certainly includes present business conditions and what is on the horizon, the part that we can see by gazing upon it from the present. They buy it with a future expectation of price growth in the stock, what it may be worth at some point down the road, and for investors, that doesn’t mean next week, next month, or even next year, this takes us to a point well beyond the horizon.

Fundamentalists just look toward the present though and ignore the future, and just using near term business results to decide where a stock is going years from now ends up missing the mark completely. Tesla happens to be the gold standard for this huge fundamental error, and has been perennially misunderstood throughout its rise, always seen as overvalued when it is their mechanism of valuation that is broken.

Stock Prices are Solely Decided by a Bidding Process

Understanding stocks like Tesla or any high performer simply comes down to watching how much people are willing to pay for a stock, and what they are willing to pay, regardless of the reasons behind it, is what puts up the price of stocks. There are no other proximate causes, and this is not only where the rubber meets the road with the value of stocks, it’s the only thing.

The main reason behind some stocks doing so fabulously this year in the face of the economic downturn that we have been this year has been that the good choices have been so much more limited this year with so many companies struggling. If your company is not among them, like Tesla isn’t, like Amazon isn’t, like many growth companies aren’t, is an even bigger plus because investment money that may have gone elsewhere if not for these changes are going to find their way into these better stocks.

There is also the fact that people can just choose to put more money into stocks regardless, and we have really seen this during 2020. As long as the market is willing to pay more, stocks will continue upward, regardless of whatever else might be going on or what some people believe. Somehow, 2020 is thought to matter absolutely, when it may not matter at all to those who have a time horizon beyond 2020 or often well beyond it.

Companies can lose money for any amount of time, and Tesla sure did, for 17 years in fact before they managed to even generate any earnings. If you think earnings is anything more than one among a lot of different things that investors look at when they decide to invest, and especially if you think that the only earnings that matter to them are current or near term earnings, you are horribly confused.

If you are lost in the present, looking at things like how many cars Tesla is selling in the present, or even how many cars that they will sell even years from now, you are going to be pretty lost indeed, especially with a stock like Tesla and its abundance of speculation. This is just about how much people are expected to continue to pay for the stock, and the reason why this is all you need to know is because that’s all there is to know if you are wondering how a stock may move.

This gets missed by the crusty and confused set though, as they see this paying more for the future as an aberration that is in need of correction, where they expect us to move from the reality of a situation to one based upon their misunderstanding. Tesla somehow manages to become more and more overvalued over time in their minds, and even as their heads get ready to explode with their beliefs about overvaluation, they still insist on maintaining their delusions in spite of being more and more wrong as time passes.

They also sit by patiently and wait for the fundamental principle behind changing stock prices to be turned on its head, waiting for a time where the future does not matter to stock prices anymore and some other mechanism kicks in, somehow punishing stocks for their brighter future and instead giving this love to companies with a far dimmer future, by way of some invisible and imagined Robin Hood who will rob from the good stocks and give it to the bad ones.

The correct view is to see the market perceiving a bright future as being a reason to be bullish on stocks, with those stocks with a dimmer future being seen as bearish. We can even reduce this to the market being bullish on a stock means that the market is bullish on it. This should be very intuitive, unless your head is buried in the present and you ignore the fact that stock prices are never about where a stock is but instead completely about where it may be headed.

The momentum that indexes having more stocks with better potential for growth is why we have been so bullish on the Nasdaq 100 for so many years, even to the point of being bewildered as to why people would invest in the S&P 500 instead, if the goal is actually to seek better returns on our investments.

It’s not just that the fundamental approach to stocks that so many take ignores the future, as bad as that would be given that this is what we trade on exclusively when we trade stocks, it’s that their mechanism of valuation actually discounts the future, where brighter futures are seen to count against stocks rather than making them more in favor.

This takes performance and turns it on its head, where good performance is seen as bad and bad performance is somehow seen as good. Stocks like Tesla tend to scare the fundamentalists the most, but any stock that has done well serves to scare them, where they run away from the good stocks because they think that they are “too expensive” and instead run toward ones doing more poorly due to their being seen as less expensive.

Succeeding at Investing Requires Following the Money, Not False Ideas

The biggest problem with this thinking is that Tesla is seen as too expensive to them, but not to the market, which always prices stocks at a price they think is just right, not too high or low. This isn’t a theory, it’s what actually happens in practice. Tesla trades at over $600 a share for example because that’s the price that the market has deemed fair and just right in fact on that particular day.

When we see the price of stocks move up, this reflects an increasing interest in a stock. Stock prices are only determined by one thing, increasing or decreasing expectations. When we seek to select stocks to hold, it should only make sense to want those with better expectations based upon market performance than those with a lesser outlook.

The Nasdaq, for instance, beats the S&P 500 and the Dow year after year because it is comprised of better performing stocks. Stocks that outperform are more likely to continue to outperform than underperform. Past performance does not guarantee future performance, but it does serve as a reliable predictor. Investing is all about probabilities, and having probabilities on your side is just better than not.

Tesla nearly doubled in the last 4 months of 2019, and this is the sort of thing that scare the daylights out of the fundamentalists but really excite those who trade the stock and not the company. No one trades the company with public shares anyway, but the fundamentalists at least pretend to, and not only that, they try to trade on the present results of a company. Their view only focuses on the near term, and this is why we hear things like a company is so overvalued compared to their earnings of last year, this year, or a year or two into the future.

The performance of Tesla’s stock is as wild as you ever see a big stock take off, and this doubling in price over the last 4 months of 2019 has now turned into it gaining 14 times the size it was a year and four months ago. 1400% is the sort of thing that few investors can ever dream of achieving over their entire lifetimes of investing, and this is as much as the S&P 500 has returned since 1950 when we factor in inflation.

A stock that has made as much in 16 months as the benchmark S&P 500 has in the last 70 years should certainly grab people’s attention. No one knows how much higher it may climb, or what path it will take toward the future, but when something does well and good performance scares you, a stock like Tesla will scare the pants off you.

This is exactly what happens with these people, whether it is Tesla or a much tamer strong stock lately like Apple. Fundamentalists discard the good stocks in general, and much prefer mediocre ones. Their results are, not surprisingly, mediocre, and cannot even keep up to the averages. Undaunted, these folks will still do their best to try and still remain as deluded as ever about how desirable strong stocks should be.

We have been enjoying the little exercise we put together for you at the end of last year, where we assembled a little index for you of 5 of the top 10 performers of 2019, with the other criterion being finishing the year at an all-time high. With the year coming to an end soon, we can take one final look at how this group of stocks have done compared to the market.

The S&P 500 is up 15% so far this year. AMD is up 105%, Apple is up 76%, Chipotle Mexican Grill is up 70%, Lam Research is up 65%, and Copar is up 34%. That’s an average of 70%, which also beats the Nasdaq’s 45% this year, and this needs to be about beating both to make sense of this, otherwise you could have just bought the index.

We’re going to continue this experiment to show the two year horizon of these selections, stocks that have all performed exceptionally two years running now.

Buying index funds makes investing as easy as it gets, but beating them isn’t a whole lot harder if you understand that current performance does predict future performance well enough to make this a profitable idea. We love strong stocks like Tesla, and while it can’t keep this pace up, it’s more likely to outpace the indexes than not.

This is a matter of deciding based upon the odds, where it’s good to have stocks like Tesla, or that basket of stocks of ours, or other high performing stocks over those who are not performing anywhere near as well and are less likely to do so going forward.

Tesla is a high-powered machine though, and just like driving the real thing, it goes fast and is not for the feint of heart if you are looking to trade it. Investing in this is a lot easier though, where you can give it the room it needs and avoid getting whiplashed and thrown from this fast car.

Tesla had a particularly noteworthy run up in the weeks leading up to its inclusion in the S&P 500. 70% in a little over a month is pretty fast indeed. Its shares dropped in value once the addition was made official, but rest assured, being included in the S&P 500 is a very good thing for Tesla, and is still up 58% since the announcement on November 16.

When we look forward to what may be the best stocks to hold for 2021, it’s hard not to like Tesla as long as people are still willing to throw more and more money at it. Being in the big index should actually serve to stabilize it, where it’s not only bought by the indexes now, it also gets sold by them when the market itself goes the other way.

The 2021 Tesla will likely be more muted than this year’s model, but should continue to attract enough excitement to keep it a top tier stock. There’s enough horsepower under the hood with this car right now to make it considerably more desirable to ride in versus the competition generally, the S&P 500 for instance, even with Tesla in it.

The most important thing to realize is that the growth of a stock is only limited by the bidding, and when people are bidding up a stock, they tend to continue to do so at a level well above average. There are indeed important refinements that we can make, like being a little turned off by Amazon due to its performance in recent months, where investors have seemed to have gotten their fill for now, we need to make sure we are at least on the right side of good, and Tesla is still on the right side.

Ken Stephens

Chief Editor, MarketReview.com

Ken has a way of making even the most complex of ideas in finance simple enough to understand by all and looks to take every topic to a higher level.

Contact Ken: [email protected]

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