How Tesla's inclusion will impact the S&P 500's performance and valuation, according to Goldman

Published Thu, Dec 17 202012:23 PM ESTUpdated Thu, Dec 17 20201:02 PM EST

(This story is for CNBC PRO subscribers only.) After months of speculation, Tesla is finally joining the S & P 500 before trading begins on Monday. The company is the largest ever addition to the benchmark index based on market capitalization, leading investors to speculate about how the addition will impact the S & P, as well as the trillions of dollars that are benchmarked to it. Crunching the numbers, Goldman Sachs looked at how Tesla will impact S & P metrics, including valuation and performance — and the results may take some investors by surprise. With the S & P 500's multiple already sitting close to its record high, some investors might worry that Tesla's addition could make the index even more expensive, given the electric vehicle company's elevated valuation. According to estimates from FactSet, Tesla currently trades at 167 times earnings. To put that number in context, Apple and Amazon trade at 31 and 72 times forward earnings, respectively. But Goldman Sachs said this concern is flawed. Tesla's addition "will have only a minimal impact on the P/E of the index," David Kostin, Goldman Sachs' chief U.S. equity strategist, wrote in a note to clients. The firm believes Tesla's addition will lift the S & P's P/E ratio by just 0.4 multiple turns, which is "much less than most investors expect." This is because while the S & P is a market-cap weighted index, the index is typically thought of as an aggregation of its individual constituents when it comes to metrics like earnings and valuation, according to Kostin. In other words, Tesla's above-average index weighting will not translate to its valuation being more heavily counted. "Given Tesla's large size and elevated multiple, many investors erroneously intuit that the company's inclusion into the S & P 500 will lift the index's current 22x P/E multiple — which already registers close to the highest levels on record — by two multiple turns or more," he said. Since earnings is in the denominator in price-to-earnings calculations, the index's valuation is ultimately equivalent to an earnings-weighted average of companies' P/E multiples, not a market cap-weighted average. While Tesla will hold a roughly 1.5% market cap weight in the S & P, Goldman said consensus estimates for its 2021 earnings represent just 0.2% of total S & P earnings. "The inclusion will lift the aggregate index P/E multiple by slightly less than 1.5%, or less than half of a P/E multiple turn. This impact would be similar whether the stock traded at a P/E multiple of 170x, 500x, or 1000x," Kostin added. Tesla's addition to the S & P will have a larger impact on the index's market cap-weighted P/E multiple — two multiple turns — but this metric is less frequently cited, according to Goldman. Tesla's impact on performance When it comes to the S & P 500's return, Kostin said Tesla's inclusion could "have a meaningful impact on index performance." The company has been on a tear this year, and shares have gained roughly 660%. The stock has outperformed the S & P by about 640 percentage points. "Had it been a constituent all year, it would have lifted the total index return by roughly 200 [basis points], from 16% to 18%," Goldman said. Elsewhere, the firm predicts that Tesla's addition to the S & P 500 will reduce per-share metrics including EPS and dividends by about 1%. This is regardless of Tesla's fundamental impact, since it is based on the S & P 500 divisor growing by about 1.5% once Tesla joins the index. "Including Tesla's expected earnings, the bottom-up consensus 2021 EPS estimate should move from $169 today to $167," Kostin wrote. "Our top-down S & P 500 EPS estimate for next year is $175," he added. Goldman upgraded shares of Tesla to a buy rating earlier in December , saying the company will sustain leadership in a quickly growing industry. The firm also lifted its 12-month price target to $780 from $455 per share. Tesla gained about 2% on Thursday, trading around $635.50 per share. How will Tesla be added to the S & P? S & P Dow Jones Indices announced on Nov. 16 that Tesla would join the S & P 500 in December. Given the company's size, the index provider sought feedback from the investment community over whether to add Tesla all at once or in two separate tranches. S & P Dow Jones Indices ultimately decided on the former , noting that Tesla's addition would be based on closing prices from this Friday and therefore coincide with the expiration of stock options and stock futures. The high trading volume on that day would help ease the transition, the firm said. Tesla will replace Apartment Investment and Management Co. , and will also join the S & P 100. There's currently over $11.2 trillion in assets benchmarked to the S & P 500, with roughly $4.6 trillion of the total in indexed funds. According to Jefferies, this means $74 billion worth of Tesla stock — or 118 million shares — will need to be bought based on the company's float-adjusted market cap of roughly $480 billion. But while more than $70 billion might sound like a lot, Jefferies added that this only represents three days of Tesla's trading volume. - CNBC's Michael Bloom contributed reporting.

A Tesla car in London.

SOPA Images | LightRocket | Getty Images

(This story is for CNBC PRO subscribers only.)

After months of speculation, Tesla is finally joining the S&P 500 before trading begins on Monday. The company is the largest ever addition to the benchmark index based on market capitalization, leading investors to speculate about how the addition will impact the S&P, as well as the trillions of dollars that are benchmarked to it.

Crunching the numbers, Goldman Sachs looked at how Tesla will impact S&P metrics, including valuation and performance — and the results may take some investors by surprise.