Tesla is not a stock we own, but a look at recent news shows just how different our investment approach is from that of speculators and fans of indexing.
Tesla CEO Elon Musk recently warned employees that if the electric-vehicle maker doesn’t meet its operating goals, the stock could be “crushed like a souffle under a sledgehammer.”
It makes sense for him to worry. Speculators have driven the market value of Tesla higher than the combined value of the 12 largest global auto companies. Company profits are meager, and if they don’t grow fast enough, the stock could get walloped.
Who Cares About Price? Not the S&P Index Committee.
Despite this high price, the Committee that decides which companies to include in the S&P 500 voted to add Tesla to their Index. That means that investors who own index funds tied to the S&P now own it.
But isn’t the goal of investing to buy low and sell high? Why would the Index Committee add what seems to be an overvalued stock? Why would they continue to include other stocks that seem overpriced?
Well, because the stated aim of the Index Committee is to maintain a “representative” list of leading U.S. companies. They don’t make judgements about whether a stock is cheap or expensive.
Neither Do Index Funds
Index funds don’t make judgements about value either. They simply assume that prices are fair. Here is their investment process: Is this stock in the index we target? If so, buy it.
In contrast, we have a detailed, three-part test to evaluate stocks. We look at the quality of a business and assess the strategy and trustworthiness of management. We estimate the value of a business and compare it to the current market price.
So, Should Elon Worry About His Stock Price?
Fans of index funds would advise Elon to stay calm. The market has considered all relevant facts and has arrived at a fair price.
But markets are made up of people, and people are subject to swings in emotion. Prices can run far above what a cool-headed appraisal would indicate. This seems to be what Musk, founder and CEO of the company, is concerned about. And who knows more about a souffle than the baker?
Barry Dunaway, CFA®
Managing Director
America First Investment Advisors, LLC
Omaha, Nebraska
This post expresses the views of the author as of the date of publication. America First Investment Advisors has no obligation to update the information in it. Be aware that past performance is no indication of future performance, and that wherever there is the potential for profit there is also the possibility of loss.
