Palantir will be added to the S&P 500 on September 23rd.

The stock spiked on the news yesterday, closing higher by 14%.

Palantir will be joined by Dell Technologies and Erie Insurance, whose stock prices saw similar spikes yesterday. 

The price increases coincide with what’s known as the “S&P 500 inclusion effect.”

This describes the tendency for a stock's price to spike on news that it will join a widely followed benchmark, like the S&P 500, only to stagnate following the addition. 

The rationale here is simple: roughly $16 trillion in assets directly or indirectly tracks the S&P 500. 

Yes, trillion. 

In short, the best way for the managers of this $16 trillion to accurately track the S&P 500 is to buy shares in all underlying assets. 

As of September 23rd, Palantir, Dell, and Erie will be on that list of underlying assets. 

Looking more specifically at Palantir, even if it’s assigned a tiny weight in the index (say 0.1%), 0.1% of $16 trillion is still a big number. 

That’s a lot of newfound demand for the stock, hence why it spiked 14% higher yesterday. 

Unfortunately, the hype surrounding the inclusion effect doesn’t last long. 

After being included into the index, stocks typically stagnate or trade lower. 

There’s a few different reasons for this. 

The two primary reasons are: 

1. Due to the rules regulating inclusion into the S&P 500, new stocks have typically already seen significant price appreciation. Palantir is higher year-to-date by 102%, making continued short-term gains more difficult. 
2. The price spikes on inclusion announcement dates have proven so lucrative (14% for Palantir yesterday) that much of the upside gets priced in on announcement day, also making continued short-term gains difficult. 

It’s important to note that Palantir’s underlying earnings haven’t changed. 

Just a new wave of buyers have stepped in to push the price (and more importantly valuation) higher. 

A good recent example is Tesla. 

Standard & Poor’s announced it would add Tesla to the S&P 500 on November 16, 2020.

Between that moment and when it was added on December 18th, the stock shot up over 50%.

Once added to the index, it immediately became the fifth largest stock in the S&P 500.

Then, shortly after being added to the index, Tesla’s stock price went nowhere.

In fact, the stock is lower today than back in late 2020. 

Certainly other factors have impacted Tesla’s stock since inclusion into the S&P 500. 

But the 50% run-up in anticipation of its addition to the S&P 500 certainly made the stock expensive, limiting its upside. 

Palantir is likely a similar story. 

The stock trades at 200x earnings. It trades at 80x next year’s earnings. 

As bullish as I am on artificial intelligence, I can’t support Palantir’s current sky-high valuation. 

So while the funds that track the S&P 500 have no choice but to buy PLTR stock at this high valuation, you, on the other hand, certainly do have a choice.

There are plenty of AI stocks with high growth potential trading at reasonable valuations. 

After yesterday’s price spike, Palantir isn’t one of them.