The pattern reverses in the year after an index change. The average addition rises an additional 1% relative to the market on the day after it is added to the index, then loses about 2% relative to the market over the following year. If the addition is a mega-cap, there is a 2% follow-through share-price rise the day after the effective date, followed by a drop of 7% over the next year (Arnott, Kalesnik, and Wu, 2018).
Our research further shows that the average deletion drops 1% more the day after its removal from the index, then beats the market by an average of 20% over the next year. The S&P 500 is designed to buy high and sell low, which results in a performance gap of 24% between additions of mega-cap stocks and discretionary deletions from the day after the change is made until 12 months later.On December 11, 10 days ahead of the index rebalance date (December 21) on which Tesla is scheduled to enter the S&P 500, the S&P index committee announced it is dropping Apartment Investment and Management (Aimco) (NYSE:AIV) to free up space for Tesla. AIV’s price has dropped 36%, lagging the market by 52%, in the 12 months before the announcement of its removal from the S&P 500. This price decrease is likely a key reason the S&P index committee decided to drop it.
AIV’s price fell further, by more than 4%, in the after-market trading session following the December 11 announcement it would be removed from the index. Both Tesla and Aimco followed the familiar pattern: Tesla’s share price surged, while Aimco's share price plummeted before the index adjustment date. If history is a guide, the prospects for each of these stocks may substantially reverse over the next year, with Tesla underperforming and Aimco recovering nicely.
Our 2018 research showed that the performance gap between index additions and deletions is stronger for the additions with the largest capitalization. But Tesla is not just a mega-cap company—after the S&P decision on November 16, it ranked sixth among all US public companies in terms of capitalization. Previously, the number six position in the S&P 500 was held by Berkshire Hathaway, a company with 7 times Tesla’s last quarterly revenue (third quarter 2020) and 91 times Tesla’s last quarterly net income.
Tesla’s size raises another point of concern: typically, only 2 to 3 of the top 10 stocks ranked by global market-cap remain in that list 10 years later (Arnott, Kalesnik, and Wu, 2018). Importantly, the 7 or 8 companies that drop off the top 10 list over the following decade all underperform the newcomers to the list 10 years later. Contributing drivers to the aging and fading top dogs’ decline are 1) more directed competition after becoming a top dog; 2) greater regulation seeking to extract revenues from perceived cash cows and seeking control over perceived predatory practices; and 3) the likely overvaluation that drove these companies to top-dog status in the first place. The top-dog status of Tesla further tilts the odds of price underperformance, and not in Tesla’s favor.