1) If anybody still finds it difficult to understand why S&P 500 inclusion & changes in short interest can have a significant long term impact on share price, in this thread I’ll explain more clearly what a share price is and what can change it.
2) I define a share price as:
The equilibrium where the $ amount of capital Active Investors are willing to invest in the company at the current share price is equal to the $ value of shares (plus $ of synthetic shares created by shorts) available for Active investors to purchase
The equilibrium where the $ amount of capital Active Investors are willing to invest in the company at the current share price is equal to the $ value of shares (plus $ of synthetic shares created by shorts) available for Active investors to purchase
3) A company’s stock price is not the true value of a company’s equity. Its also not the average valuation of the company by investors in the market. Nobody knows the true value of a company’s equity, not an individual investor, not company management & not the market as a whole.
4) A company’s true value is the discounted value of its real future cash flows. We can make educated guesses what these future cash flows will be but don't know for certain so it is impossible to know a company’s true value. It is very unlikely a share price reflects this value.
5) On my share price definition above, a share price is changed by 4 key things:
A) Changes in the $ amount of capital a company’s current active investors are willing to invest at the current share price.
A) Changes in the $ amount of capital a company’s current active investors are willing to invest at the current share price.
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B) Changes in valuation estimates or “gut feel” investment decisions from active investors that are already valuing/considering the company but previously chose not to be invested.
B) Changes in valuation estimates or “gut feel” investment decisions from active investors that are already valuing/considering the company but previously chose not to be invested.
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C) Increased or decreased $ pool of capital considering the stock & making fair value estimates.
D) Changes to the $ value of shares available for active investors to purchase.
I’ll explain these in more detail:
C) Increased or decreased $ pool of capital considering the stock & making fair value estimates.
D) Changes to the $ value of shares available for active investors to purchase.
I’ll explain these in more detail:
8) A) Changes in the $ amount of capital a company’s current active investors are willing to invest at the current share price:
The decision whether a company is currently undervalued or overvalued may be based on detailed models & share price targets.
The decision whether a company is currently undervalued or overvalued may be based on detailed models & share price targets.
9) But it could equally be based on emotion, or “gut feel”, or anticipation of upcoming catalysts (such as S&P 500 inclusion or M&A) or signals from technical analysis.
10) The $ amount of capital these active investors invest in a specific company they think is undervalued can be impacted by total $ size of their funds, conviction on the trade & risk level of the trade. It can also be constrained by fund mandate position or risk limits.
11) For people that do build a firm valuation model there is still huge disagreement on which valuation methodologies to use & which fundamental assumptions to make about future cash flow. Some investors may make all investment decisions based on multiples of historic financials.
12) Some may make a single base case model & perform a discounted cash flow analysis. Some may make many or even hundreds of different models for future results & take a probability weighted average valuation.
13) These valuations or gut feel decisions will mostly be changed by changes to; a company’s fundamentals, share price, media/analyst narrative, technical analysis or upcoming catalysts.
14) Often there is strong correlation between an investor's valuation & the stock price; As the stock goes up they tweak their models to justify a higher valuation. This is because emotion & gut feel is a far larger driver of investments than investors admit (even to themselves).
15) If Group A investors increase or decrease the $ capital invested in a company it will impact share price. As a price rises the value of capital they have invested will rise & they have to check if they can or want to maintain this increased value or else reduce shares held.
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B) Changes in valuation estimates or “gut feel” investment decisions from active investors that are already valuing/considering the company but previously chose not to be invested.
This is very similar to the Group A investors above.
B) Changes in valuation estimates or “gut feel” investment decisions from active investors that are already valuing/considering the company but previously chose not to be invested.
This is very similar to the Group A investors above.
17) These investors were also aware of the company & were considering an investment, but these investors had previously decided the company was overvalued & did not invest.
18) This view might change due to changes to a company’s fundamentals, share price, media/analysts narrative, technicals or upcoming catalysts.
If these investors now decide the company is undervalued, they will join group A & any share purchases will increase the share price.
If these investors now decide the company is undervalued, they will join group A & any share purchases will increase the share price.
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C) Increased or decreased $ pool of capital considering the stock & making fair value estimates:
The pool of investors considering a specific investment may increase because people simply had not heard about the stock before.
C) Increased or decreased $ pool of capital considering the stock & making fair value estimates:
The pool of investors considering a specific investment may increase because people simply had not heard about the stock before.
20) It could increase because some investors had previously dismissed the stock based off a media narrative or equity analyst reports without ever forming their own valuation opinion, but when the narrative changed they decided to do some work.
21) It could increase because investors had previously been unable to invest based on fund mandate requirements such as only profitable companies or only companies in the S&P or only dividend paying companies & one of these factors now changed.
22) The pool of investors may decrease because a fund decided to cut exposure to a particular sector, or the stock was too volatile & they didn't want the stress etc. Investors in group C can move into group B or A & vice versa. If they move into group A it increases share price.
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D) Changes to $ value of shares available for active investors to purchase:
This $ value of shares available is primarily driven by the share price, so as a share price rises, the $ capital group A is willing to commit has to increase to maintain the new share price.
D) Changes to $ value of shares available for active investors to purchase:
This $ value of shares available is primarily driven by the share price, so as a share price rises, the $ capital group A is willing to commit has to increase to maintain the new share price.
24) However, the $ value of shares available for active investors/Group A to purchase is also impacted by change in available share count due to:
25) Share buybacks, short interest, share issuance, purchases by passive funds (these shares are effectively taken out of the market & reduces the share pool available for active investors), share lock up expiry, changes in shares held by Options or Convert Delta Hedging etc.
26) A reduction in number of these shares reduces the pool of shares that active investors are competing to buy and hence lowers the threshold of investor capital needed for the company to reach a particular share price.
27) So S&P 500 inclusion for $TSLA impacts all 4 of these share price drivers: A) Investors in Group A may choose to invest more capital in anticipation of a S&P share price bump (likely already happening to some extent), B) Group B may move into Group A for the same reason,
28) C) Group C may be forced to start looking at Tesla & move into Group A or B because their funds benchmark the S&P 500 & the decision whether or not to invest in Tesla will now impact their performance vs their benchmark
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& D) Passive funds tracking the S&P 500 will be forced to buy 15-20 million Tesla shares thus removing them from the pool of shares active investors are competing over.
& D) Passive funds tracking the S&P 500 will be forced to buy 15-20 million Tesla shares thus removing them from the pool of shares active investors are competing over.
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