Uber will join S&P 500 ???? Will it react to well known Wall Street 'phenomenon'?

After several months of stock market rollercoaster on Uber's shares, the company's shares has managed to rise this year, up nearly 150%, making its return comparable to Bitcoin. Now, Uber is at a turning point. Recently, it managed to reach profitability, and now the company faces a great opportunity. On December 18, this year, Uber will join the 'elite' group of companies listed on the largest U.S. index, the S&P 500, where it will replace Sealed Air Corp.

The last companies that joined the main stock index were Epam Systems in 2021 and Tesla, in 2020. This time, the event is also significant because of Uber's $130 billion market capitalization, which is nearly 4 times the average S&P 500 company's capitalization of about $31 billion. But does getting into the ranks of the 500 largest U.S.-listed companies and meeting all the requirements really mean the opening of a whole new chapter for the company？

What to expect from the 'S&P 500 phenomenon' ？

On Wall Street, the 'S&P 500 phenomenon' has been known for years. In a nutshell, it consists in the positive impact of joining the index, on the price of shares. This is due not only to the greater 'confidence' and prestige of the company itself, but also to institutional interest. ETFs on the S&P 500 affect the valuations of these companies, as they are forced to buy immediately when a company is included in the index. It is worth noting that ETFs on the S&P 500 index are the largest funds of their kind in the world.

In early 2023, U.S. funds (including ETFs) tracking the S&P 500 had total assets of $5.7 trillion. Since then, they have likely grown at double-digit rates, with the ongoing rally on Wall Street and an 18% rally in the benchmark. Their valuation now accounts for about ⅛ of the value of the entire stock market, and the three largest ETFs tracking the S&P 500 have a combined value of about $1.2 trillion. This shows that Uber can count on significant revenue, subject to further improvement in stock market sentiment, in the long term.

Historically, joining the S&P 500 index has temporarily supported sentiments, but this in itself does not determine a company's stock market 'success'. Tesla gained nearly 19% since its debut. Epam Systems in 2021 debut turned out to be exceptionally weak, moments after initial rally, supply was triggered, dominating the stock to this day. On the chart above, we can see price change of each company shares, 365 days after S&P 500 debut. Source: XTB Research, Bloomberg Finance LP

Concerns about 'S&P 500 phenomenon'

Of course, while joining the index is of some importance (especially at a time when indexes are rising and funds are forced to buy shares) it is also worth considering that they may just as well be forced to sell them. What's more, the fact that the company has already entered the S&P 500 index means that it's hard to expect its stock to benefit once again from speculation around its possible inclusion. But Uber is a powerful company with a significant market capitalization, and joining the S&P 500 will help it attract more investor attention.

It seems rather naïve, to think that Uber's stock will rise just because the company has joined the S&P 500, although Oppenhaimer analysts say this will accelerate and improve the overall conditions for its stock to rise through, among other things, a share buyback program, improving investor's sentiment around continuing to generate shareholder value. As it turns out, there's a whole host of reasons why Uber may be doing great, and it's not at all due to the event that awaits the company next Monday. From a competent board of directors and improving margins to

A key？ Net margins and higher free cash-flow

Given that the company is still in a low-margin business, a key aspect for the company, is continued scale and expansion. But the real 'leverage' on returns generated for shareholders are margins. So far, management is growing the company brilliantly, and Uber is no longer the same company that was 'burning cash' in 2019, raising concerns around whether it could ever achieve profitability, with galloping costs and rising competitors. Interestingly, since the Covid-19 pandemic, the Uber Eats business has become a major source of revenue, 'dethroning' the transportation business. Few could have seen this coming.

Had the company not introduced the Eats service and been able to build an entirely new business from scratch, on top of its existing structure, it would likely have suffered an uninspiring fate in the face of the pandemic, and today could only 'dream' about joining an S&P 500. Management showed competence and determination. Today Uber, as well as its shareholders, are collectively reaping the rewards. Over the past four quarters, the company has generated $1 billion in profits, and in Q3 it reported $221 million on revenues of $9.29 billion. To achieve this, among other things, it was forced to lay off nearly 3,500 employees.

Lower delivery costs have improved margins. The company is aiming high and comparing itself to major technology companies like Google and Microsoft. The goal is to dominate the market for transportation and deliveries. A key to its continued growth, in the stock market, will be further gradual improvement in margins (which is already happening). Uber gross margins have been declining, admittedly since 2018, but its net margin has risen from close to -80% in Q1 2020 and -40% in mid-2022, to positive 2.93% today. And it must be said that from a level close to 3%, there is considerable upside potential, supporting higher earnings per share expectations.

Uber Technologies stock chart (D1)

Shares of Uber Technology (UBER.US), D1 interval.

In the short term, the impact of Uber joining the S&P 500 index on the stock price is not clear, and it seems that a lot will depend on whether market sentiment does not deteriorate by next Monday. If this is the case, joining the S&P 500 may give the market an argument to take profits - 'sell the news' scenario. On the other hand joining the S&P 500 in the long term is beneficial for the company both in the medium and long term.