The electric vehicle pioneer’s business has plenty of long-term promise, but it’s the short run that most people are looking at right now.
Nov. 25, 2020
This article originally appears on The Motley Fool, written by Dan Caplinger.
Tesla (NASDAQ:TSLA) has been one of the biggest stock stories of 2020. With shares sporting gains of nearly 550% just since Jan. 1, those who’ve believed in the business model that CEO Elon Musk has built have profited handsomely. Musk himself has been among the biggest winners in Tesla stock, vaulting to the No. 3 spot among the world’s richest people, according to Forbes.
In the long run, stock movements reflect the success or failure of a company’s underlying business. Short-term share price swings are a lot harder to gauge. Nevertheless, there’s a good reason why Tesla’s stock looks like it’s headed to $600 per share in the very near future. It could go much higher if the conditions are right.
It’s a matter of supply and demand
Tesla has a lot of metrics that investors watch from quarter to quarter. Delivery figures are probably the most important, typically coming out in the first days of each new quarter. Earnings reports obviously carry substantial weight as well.
With all those catalysts behind us for the current quarter, the amount of fundamental news affecting Tesla between now and the end of the year is likely to be small. That leaves the stock price more susceptible to factors that don’t involve Tesla’s business strength.
Specifically, the biggest driver of Tesla stock between now and the end of the year is likely to be the decision from S&P Dow Jones Indices to add Tesla to the S&P 500 index. The bull case is pretty simple:
- Current shareholders know that index funds tracking the S&P 500 will need to buy shares of Tesla in substantial quantities on or before Dec. 21.
- Knowing that all that buying is on the horizon, there’s little reason for those shareholders to sell now.
The sheer mass of money following the S&P 500 is incredible. S&P Dow Jones Indices reports that $11.2 trillion in assets uses the S&P 500 as a benchmark for return comparison purposes. Of that amount, more than 40% — $4.6 trillion — are indexed assets that are tied directly to the S&P 500’s components.
A whole lot of buying is coming
Based on Tesla’s current market capitalization, estimates suggest that it will likely have a weighting of between 1% and 1.5% of the S&P 500. Take that amount and apply it to the $4.6 trillion in S&P-tracking assets, and you get $46 billion to $69 billion in Tesla stock that index funds will have to buy come late December.
That amount is so huge that S&P Dow Jones has looked at spreading out Tesla’s inclusion over a couple of days. No final decision has been made on that front, but breaking up the move could make it easier for those forced buyers to find willing sellers.
Is a short squeeze coming?
The other thing to keep in mind is that Tesla already has many investors betting against its stock. As of the end of October, nearly 48 million shares of Tesla stock — worth more than $25 billion at current prices — were sold short. That represented 5% of shares outstanding.
If index-related buyers end up pushing the stock price higher, the resulting squeeze on short-sellers could lead to an even sharper upward move. Admittedly, after the big gains in Tesla shares this year, anyone selling the stock short has to be prepared for huge risk, and so they’re less likely to get squeezed out than most short-sellers would. Nevertheless, there’s only so much short-selling investors are willing to lose. That could leave the stock open to a big short-term bump as well.
The holidays will be interesting for Tesla
For many investors, the addition of Tesla to their index fund holdings will represent the first time they’ve owned shares of the electric automaker stock. They don’t have a choice in the matter.
However, if you think Tesla’s underlying business justifies the big run-up in its stock price this year, then you might prefer not to wait until the index funds buy-in. In the short run, a big rise in the share price would make all the sense in the world.
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