Uber is Now Being Targeted by the Inclusion Curse of the S&P 500

Uber Technologies is poised to enter the prestigious S&P 500, marking a significant milestone four years after its initial public offering and approaching its all-time peak valuation. This occurrence aligns with a recurring pattern where companies tend to be added to the S&P 500 at the zenith of their market values. Investors in Uber can anticipate positive developments as index investors, managing around $12 trillion directly or indirectly linked to the S&P 500, will be compelled to acquire Uber shares to include them in the index.

‍

However, this addition may bring unfavorable consequences for existing index holders, as Uber has evolved into a relatively expensive stock over its four-year public trading history. Factors contributing to its elevated cost include the surge in its share price, which climbed from the $45 IPO in May 2019 to nearly $60, with a notable jump from $40 just a month ago. Additionally, the company has significantly increased its outstanding shares, rising from approximately 1.6 billion in 2019 to almost 2.1 billion at present, constituting a remarkable 25% growth.

‍

When considering all these elements, the overall expense associated with incorporating Uber into the index is substantial, with a market capitalization of $122 billion. This would position Uber as the 66th largest company in the S&P 500, comparable to industry giants like American Express, Lowe’s, and AT&T.

‍

The timing of Uber's inclusion in the S&P 500 can be attributed to the index's inclusion rules, particularly the requirement for positive earnings in the most recent quarter and positive total earnings over the trailing four consecutive quarters. Uber satisfies these criteria by reporting profitability in both the last quarter and the cumulative four quarters.

‍

However, a potential concern arises from what is colloquially known as the "S&P 500 inclusion effect." This effect refers to the tendency of a company's stock price to increase from the moment of inclusion announcement (or even earlier) until the actual inclusion date. There is a corresponding phenomenon called the "S&P 500 curse," where stocks added to the index underperform shortly after inclusion.

‍

This phenomenon has gained prominence in the era of passive indexing, with Tesla serving as a notable example. Following its inclusion in the S&P 500, Tesla's stock price surged over 50%, securing its position as the fifth-largest stock in the index. However, the stock's performance flattened out in the subsequent year.

‍

Studies have shown that stocks added to the S&P 500 exhibit positive abnormal returns during the announcement-to-inclusion period, primarily due to increased investor awareness. Nonetheless, the McKinsey study indicates that this positive impact is typically short-lived, lasting about 45 days on average.

‍

In acknowledging the inclusion effect, Standard & Poor's suggested in a 2021 paper that the impact may be in "structural decline" due to improvements in stock liquidity in recent years. Despite this, the act of adding a company to the S&P 500, or speculating about it, tends to temporarily overvalue the company, with indexers essentially "buying high," raising the likelihood of underperformance in the future.

‍

For Uber, the looming entry into the S&P 500 on December 18th is anticipated, but questions persist among indexers about whether it's a matter of "buying high" or "buying even higher," especially considering its current price of $58.63, approaching the all-time closing high of $60.63 on February 12, 2021.