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Is Tesla on Track to Join the Elite S&P 500 Index This Year?

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Tesla (TSLA - Free Report) has had a significant impact on the auto industry, which is witnessing digital transformation. It has an ambitious vision for a future of electric and autonomous vehicles, which is highly encouraging. Notably, since its IPO in 2010, Tesla has skyrocketed 2,623%, breezing past the S&P 500’s 224% total return during the decade. Over the past few months, the stock has been on a tear. This streak of the electric vehicle (EV) pioneer continued in fourth-quarter 2019, wherein it easily topped earnings and revenue estimates. 

January 2020 was Tesla’s best month since 2013, wherein it added $40 billion in market capitalization. The company, which is currently valued at more than $115 billion, zoomed past the combined value of General Motors (GM - Free Report) and Ford (F - Free Report) . Tesla is currently the second-most valuable car manufacturer, just behind Toyota Motor (TM - Free Report) . While Tesla has taken the financial markets by storm with its breathtaking rally and achieved various milestones, one key question remains: When will this Zacks Rank #3 (Hold) company enter the prestigious S&P 500 club? You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Eligibility Criteria for Inclusion in the S&P 500

The S&P 500 is a market-capitalization-weighted index of the 500 largest U.S. publicly-traded companies. What’s important, it actually makes up for around 80% of the total U.S. stock market capitalization. So, how does a stock get added to the S&P 500 Index? Well, among several criteria that are needed to be met, which include: a company should be headquartered in the United States and have a market capitalization of at least $8.2 billion (this number fluctuates according to the stock market’s booms and busts).The stock price must be at least $1 per share and the company must file 10K annual report. Moreover, at least 50% of the firm’s stock must be available to the public, and a minimum of 50% of its fixed assets and revenues must be generated in the United States.

Finally, the last reported quarter should be profitable for the stock and aggregate profit is needed to be generated over the trailing four quarters. The S&P inclusion criterion on their website states, “The sum of the most recent four consecutive quarters’ Generally Accepted Accounting Principles (GAAP) earnings (net income excluding discontinued operations) should be positive as should the most recent quarter.”

What’s Hindering Tesla’s Entry Into the S&P 500?

Notably, Tesla is the most valuable U.S. firm that is not in the S&P 500 list. While the EV maker qualifies to join the S&P 500 Index in terms of every other parameter including liquidity, market cap and domestic headquarters, there is just one hurdle to be crossed. And that criterion is profitability.

Tesla has not been able to achieve profitability for four consecutive quarters. While the firm raked in net income of $105 million and $143 million in the fourth and third quarters of 2019, respectively, it reported a combined loss of $1,110 million in the first two quarters of 2019. As such, Tesla requires to report earnings in the next two quarters to become eligible to be part of the S&P 500 before 2020.

Tesla Could Join the S&P 500 This Year

Tesla’s second consecutive quarter of profit brings it a step closer to its inclusion in the S&P 500 Index. With two straight profitable quarters and various tailwinds surrounding the company, we believe that a ‘sustained profitability’ promised by the CEO Elon Musk is well within the realm of possibility for Tesla.

There are a number of catalysts to support the company’s earnings going forward, which will enable it to make its debut in the S&P 500 list this year.

High demand for Model 3 vehicle is definitely a booster. In full-year 2019, Tesla delivered 367,500 vehicles, reflecting an increase of 50% year over year. For full-year 2020, the company expects vehicle deliveries to exceed 500,000 units. Higher volumes should enable Tesla to achieve cost and production efficiencies, thereby strengthening margins. 

Automotive gross profit is on the rise over the last three quarters and the company seems to be trying its best to eke out more gross profits in the coming quarters. With production anticipated to increase and improved battery cell costs, the trend is not expected to reverse anytime soon.

Tesla is reaping benefits from cost-cut strategies and operational efficiency. In 2019, operating expenses declined 6.6% year over year to $4,138 million. Persistent cost control across the business had helped the firm to generate positive free cash flow of $1,078 million in 2019compared with negative FCF recorded in 2018. Volume growth and successful cost efficiencies are likely to aid the firm’s earnings and FCF growth. 

Model Y, which is slated to launch in the summer of 2020, will add incremental income to the company. The firm’s Shanghai Gigafactory, wherein deliveries have already begun, is also a positive catalyst. Impressive sales of existing products, ambitious product lineup including Semi truck and Roadster, along with a new battery technology are expected to boost its income. In addition to increasing automotive revenues, the firm’s energy generation and storage revenues are also boosting Tesla’s prospects. Notably, both solar and storage deployments will be up at least 50% in 2020.Solar Glass Roof, Powerwall and Powerpack are also expected to enhance its prospects.

Words of Caution

While there’s a lot of optimism surrounding the stock, it should not be forgotten that Tesla has had a hard time to generate profits for four consecutive quarters. Not to forget, the company had managed to deliver two consecutive profitable quarters in 2018 as well, before losing ground. Tesla, which is yet to turn a profit on an annual basis, holds a debt-to-capital ratio of 64%. Investors should remember that Tesla is one of Wall Street’s most-shorted stocks, with around $15-billion bearish bets placed against it. 

With China being the biggest EV market, the country’s economic slowdown may weigh on the company’s prospects. Tesla Model 3 production is likely to get delayed in Shanghai, as the company has temporarily suspended operations because of the deadly coronavirus outbreak.

As it is, the first quarter is typically a relatively weak one for auto sales. Although the king of EV is becoming efficient, one cannot ignore the risk of rising expenses amid the launch and ramp of new products.

However, if Tesla is able to navigate through these challenges and book a profit in the first quarter of 2019, the second quarter is also likely to be profitable. If things go well, Tesla would qualify to join the S&P 500 in the second half of this year.

Final Thoughts

Despite some concerns, the narrative for this stock’s $115-billion market cap is still compelling, considering how quickly the firm has been building out its base. If Tesla gets added to the S&P list, the company will most likely witness short-term gains as stocks do get an immediate boost on joining major indices like the S&P 500. While there might be potential short-term gains, the index inclusion effect may not last long. However, what matters is the fact that an inclusion in the S&P 500 will increase the company’s credibility.

So, will the stock get added to the prestigious S&P 500 Index and 2020 turn out to be an eventful year for Tesla? Or will it again lose the chance like the last time? Well, only time will tell that. Nonetheless, with various positives surrounding the stock, one can expect the stock to join the S&P 500 list this year.

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