Tesla (TSLA  ) shares were 6.5% lower after hours following news that it wasn't selected for inclusion into the S&P 500 Index (SPY  ). Given that the company had attained four straight profitable quarters and has become the 19th largest company on the U.S. stock exchanges, there was an expectation that Tesla would be included.

Instead of Tesla, Etsy (ETSY  ), Teradyne (TER  ), and Catalent (CTLT  ) were picked to join the index. Shares in these companies were higher between 2 and 5% in post-market trading following the news.

In order to be eligible, companies have to be worth over $8.2 billion and have four straight quarters of profitability. The decision to add or delete companies from the index is made by a committee with the intent to track the overall growth and composition of the U.S. economy.

It's likely that Tesla's cloudy outlook on near-term profits made the committee elect not to include it. Additionally, much of its profits come from tax credits rather than its operations which also brings some intrinsic uncertainty.

Stock Price Impact

Tesla's stock is one of the standout performers in 2020. Year to date, the stock is up 5x and at its recent high was 6.3x higher.

What's puzzling is that from August 11 to August 31, the stock gained nearly 100%. The only news was the rumors that it was going to be included in the S&P 500 and its announcement of a 5:1 stock split. So far in September, the stock is down nearly 20%.

This type of reaction to news that has nothing to do with the underlying business is a clear sign of froth. It doesn't mean that the stock's run is over, but it means that the "greater fool theory" is in play. Essentially, Tesla's stock is going up on the expectation that other people will buy the stock.

It's reminiscent of the dot.com bubble when stocks would climb meteorically on stock-splits and analyst upgrades. That behavior also didn't make logical sense, but it continued for so long, that skeptics started to look foolish and the bulls started to look like sages.

In Tesla's case, if it was included in the S&P 500 then fund that passively and actively track the S&P 500 would have had to buy 120 million shares of Tesla. However, historically, there's no indication of outperformance when a company joins a major index.