Why Tesla's stock price has room to grow: Analyst

CNBC's "Power Lunch" team breaks down Tesla's addition to the S&P 500 with Joe Osha of JMP Securities and Tim Higgins of the Wall Street Journal. Subscribe to CNBC PRO for access to investor and analyst insights on Tesla and more: https://cnb.cx/2BT2E7y

The index fund has thoroughly disrupted the role of active stock pickers in the market, but in an era of accelerating disruptive business models across sectors of the economy, stocks like Tesla remind investors that they still need to make some conviction bets to generate above-average returns.

Tesla will begin trading next Monday morning, as part of the S&P 500 index through which most investors now get their core U.S. large-cap market exposure. Many index fund investors may be wondering what it will mean — both the potential gains and risks — for their portfolio to get a dose of Elon Musk’s high-flying electric vehicle and renewable energy company after its huge run in 2020.

The answer: Not all that much of a difference. At the relatively small weighting that Tesla will have in the index, even as one of its largest holdings, Tesla will not hold outsize influence over an index fund investor’s return whether it goes up or down by a lot in any given year.

The Tesla S&P 500 inclusion event, by one measure, is a sign of just how powerful index investing has become — it is the biggest stock addition ever and it is being done all at once. But as Tesla enters the S&P 500 after a decade as a public company and an astronomical total return since its IPO price of $17 in 2010, index fund investors may also wonder what they have missed out on already.

if an investor had put $5 of every $100 invested in an S&P 500 index fund into Tesla shares at the beginning of 2020, their return would have increased by roughly 31%, according to DataTrek Research, based on performance through last Friday, Dec. 11.

The S&P 500 price return year-to-date through Dec. 11 was 13.4%. Tesla’s price return YTD through the same date: 634.5%.

That means $100 invested in the S&P 500 at the start of the year would be worth $113.40, not including dividends, which are worth less than $2 of additional return.

If an investor put $95 in the S&P 500 at the start of the year and $5 in Tesla, the index would have risen to $107.73 and Tesla to $36.73, for a difference of $31.06 (or 31 percentage points).

Making small stock bets on big disruption

Amid a frenzied IPO market that has sent disruptive companies public and raised concerns about a repeat of the dotcom crash, there’s a lesson in the Tesla gains — but it is not the one about taking too much risk, or the stock market as a casino where the house always wins, or regretting forever having missed out on Tesla. It’s a lesson about having the conviction to take just a little risk. The $5 bet shows that you don’t have to bet big, or bet all your money, to benefit from having conviction in a disruptive business model.

Index funds, which are hard to beat for most stock pickers over the long-term, are not about to lose their place as a core portfolio ballast. But today’s top index fund holdings, the ones that dominate the S&P 500 weighting — Apple. Alphabet, Microsoft, Facebook — all made investors a lot of money before they were included in the index.

This has been the biggest year for IPOs since 2014, and more disruptive companies are coming into the public markets. Nick Colas, co-founder of DataTrek Research, says this means investors should think about where they might put a $5 “carve out” of their portfolio in 2021.

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