Country Risk: Drivers, Measures and Investment Implications - The 2026 Edition!

    I am a creature of habit in my personal and professional life, and in the context of the content that I post online, there is a ritual that I follow with my data updates. I start the year with my general data update online, and follow up with a series of posts where I examine the implications of this data for investing and corporate finance.  Since 2008, I have also done annual update papers on equity risk premiums in March of each year, with the link to the 2026 update here, and country risk in July of each year, where I look at the topics in more details, trying as best as I can to integrate the data, research and my own thinking. This year's country risk update paper is now available, and as in prior years, I will spend this post looking what causes risk to vary across countries, how to measure those risk variations and the implications for businesses and investors.

Country Risk: Relevance

  In my years as a business school student, country risk was given short shrift and I don't remember spending much time talking or thinking about it. Part of the reason was that business school education  was dollar-centric and built on the presumption that most graduates would go to work in New York, London or Tokyo, and have little need to confront country risk on a day-to-day basis. For those who raised country risk as an issue, the response was that you could, as a company or investor with global exposure, diversify it away. Both presumptions were wrong even then, and have become even more flawed over time as we have sold both companies and investors on the benefits of globalization.

    For businesses, the exposure to country risk comes from both the revenue side, as larger portions of every company's revenues come from foreign markets, and the cost side, as production gets outsourced to locales overseas. That exposure tends to increase as companies scale up, and is higher in some sectors than others; technology companies, for instance, get far more of their revenues from other non-domestic markets than manufacturing or service businesses. Outside of utilities (power, water), it is rare for a company to be entirely domestic-focused on both its revenue and cost sides. For investors, the initial draw of investing in foreign markets might have been diversification but the greater pull has come from greed, i.e., the belief that you can higher returns in the rest of the world. That process was accelerated by the creation of investment vehicles (index and mutual funds) that made investing overseas easier, the lowering of transactions costs across markets and a greater standardization of financial statements and disclosure across the globe. The home bias in portfolios, i.e., the skewing of portfolios towards domestic market investments, has not disappeared but it is lower than it was at the turn of the last century.

   The notion that country risk is diversifiable, i.e., that if you are operating or investing across the world, the risks will average out across countries, has been undercut by the increased correlation across global equity markets, and especially so during market crises (which is when you care the most).  At the risk of being hyperbolic, there is no place to hide from country risk, for either businesses or investors, and ignoring or dismissing country risk is not an option. I discovered this truth in the 1990s, when I found myself in need of a mechanism to incorporate country risk into my corporate financial analysis and valuations, and the process that you see described in this post was born from that need. I would hasten to add that the process that I describe has very little intellectual firepower behind it, puts pragmatism ahead of theory and most importantly is a work-in-process.

Country Risk: Drivers

    I don't think that there would be much disagreement, if I assert that it is riskier to invest in some parts of the world than others, but there is likely to be plenty of disagreement on why there are risk differences and which parts of the world are riskiest. In the broadest sense, I argue that variation in business risk across countries can be traced to four factors - the political structure of the country (democracy vs authoritarian), the prevalence of corruption in the country (operating as a hidden tax and distorting business outcomes), the extent of violence in the country (from internal and external forces) and the strength of the legal system in enforcing property rights and contractual obligations. 

    On the political risk front, I looked at the EIU's Democracy Index, a composite score measuring both political freedom and protections of civil liberties, with the caveat that any index that tries to measure these will make subjective judgements that not everyone will agree with. In their most recent update, here is what the EIU scores looked like around the world:

Source: Economist 
Low (High) score: Least (Most) freedom

Based on these scores, the tilt towards authoritarianism has increased over the last decade, with only 7.3% of the world's population living in democracies at the end of 2025. Note, though, that there is still an open question of whether businesses and economies do better under democratic than authoritarian regimes, and the answer in the research is at best a "maybe".  From a risk perspective, democratic regimes create more continuous risk for businesses, with elections bringing regulatory and rule changes to economies, than authoritarian regimes, where governments can promise more continuity in policy, but when change does come to the latter, it is more likely to be large and wrenching.

    

    Corruption is a fact of life in much of the world, and businesses often have no choice but to pay the price to survive and grow. Transparency International, a global coalition against corruption, tries to capture the extent of corruption, comes up with corruption scores for countries, with lower scores indicating less corruption, and the most recent edition contains the following:

Source: Transparency International
Low (High) score: Most (Least) corruption

Northern Europe has the lowest corruption scores, followed by Canada, United States and Australia, but large portions of Africa have high exposure to corruption, with Latin America and much of Asia falling in the middle. 

    Living in the midst of violence takes a toll, and that toll is extracted from businesses that try to operate in its presence. Vision of Humanity computes peace scores for countries, measuring exposure to both violence within the country as well as from wars and terrorism. The most recent peace scores are reported below:

Source: Vision of Humanity
Low (High) score: Most (Least) peaceful

Canada, Australia, Japan and much of Europe score high on the peace dimension, and while Latin America and Africa score lower, there are portions of each continent that are more peaceful. The Russia-Ukraine war has created a huge area of violence across Eastern Europe and Russia, and exposure to gun violence creates a drag on the United States.

    Businesses are dependent on the legal system  to enforce property rights as well as contractual obligations. Countries that have legal systems that are either capricious on these fronts, or hopelessly slow in acting, create challenges for businesses that operate in them, creating both costs and risks that they otherwise would not face. Property Rights Alliance is an entity that tracks international property rights across the world, and in their most recent update, their property rights scores by country are captured below:

Source: International Property Rights
Low (High) score: Least (Most) property rights

There are wide differences across regions, when it comes to legal and property rights, with Latin America, Africa and Asia lagging and Europe, Australia and much of North America leading. 

    There is one final dimension that I have added to country risk in recent years that captures exposure to climate risk. While there are many different entities that measure this exposure, each one with its own skews, the map below which shows the climate risk exposure, by country, from GermanWatch:

Source: GermanWatch
Low (High) score: Least (Most) affected

There are two reasons why climate risk has not become a bigger topic in country risk discussions. The first is that there is no part of the globe that is unaffected, making it less of a differentiator across countries on the risk dimension. The second is that climate risk, by itself, is an abstraction for businesses, until it starts affecting the bottom line, and while there are individual companies that are being impacted, the aggregate effects, at least at the moment, are not big enough to change the discussion. 

 Country Default Risk

    While country risk is determined by multiple factors, the challenge that businesses is  in consolidating all of those risks into one number. The market that does this most directly is the debt market, where, when countries (sovereigns) seek to borrow money, lenders determine the interest rates to charge them, based upon perceived default risk. To understand why lenders worry about default with sovereign debt, you can start by looking at the history of sovereign defaults in the graph below:

Source: BoC & BoE Sovereign Default Database

Debt defaults, which soared in the 1980s and 1990s, have been lower in this century, with a shift away from loan defaults (where banks are usually the lenders) to defaults in the bond market. It is also worth noting that a non-trivial portion of sovereign defaults in each year are local currency defaults, indicating that for some borrowers, the costs of defaulting are viewed as smaller than the costs of inflation arising from printing more currency to pay off debt. Over time, Latin America has been the epicenter for sovereign default, but at the end of 2023, sovereign debt in default had a wide geographical spread:

Source: BoC & BoE Sovereign Default Database

The most widely accessible measures of sovereign default risk remain sovereign ratings, with ratings agencies operating as (imperfect) arbiters. At the start of July 2026, the graph below reports the sovereign ratings for all rated countries, from S&P, Moody's and Fitch:

Source: Multiple public sources

As you can see, the ratings agencies mostly agree on their assessments of default risk, and sovereign ratings are correlated with the risk drivers (politics, corruption, violence, legal system) that we outlined in the last section. I do believe that ratings agencies, notwithstanding the critiques of bias and mis-measurement leveled against them, do a reasonably good job in their ratings assessments, but they are often slow to act, when confronted with change. 

    The sovereign CDS market offers a market-based alternative for measuring sovereign default risk, with investors making assessments of how much they would demand to insure against sovereign default in the form of (annualized) spreads. In the graph below, I list 10-year sovereign CDS spreads as of July 1, 2026:

Source: Bloomberg

Note that sovereign CDS spreads are available for only 84 countries, and that there are swaths of the world (Central and North Africa, frontier markets) where they are not available. 

Country Composite Risk

    When you lend money to governments or buy government bonds, sovereign default risk is your key concern, and both sovereign ratings and CDS spreads try to measure that risk. When running a business in a country, you are exposed to a much wider range of risks, and measuring exposure to those risks may require different measures. One alternative is country risk scores, where services evaluate how  countries measure up on different risk drivers, and come up with composite scores for these countries. In the table below, I report the country risk scores from two services - Political Risk Services (PRS) and the Economist (EIU), at the start of July 2026:

Sources: EIU (Economist) and PRS

The table illustrates three problems that you face with political risk scores. The first is that the scoring is idiosyncratic, with the Economist going from low scores for the safest countries to high scores for the riskiest, and PRS doing the reverse. The second is that each service picks different factors to consider, and different weightings, leading to scoring divergences that sometimes confound; PRS, for instance, ranks the United States as riskier than Ghana, on a composite risk basis. The third is that the scores, by themselves, are difficult to convert into inputs in financial analysis, either in cash flow or discount rate adjustment.

   It is to combat the third problem that I started estimating country equity risk premiums, and while the details of the process and the data that I use have changed over the last three decades, the basic structure has remained unchanged. I start with an estimate of the equity risk premium for a mature market, and build a country risk premium, if needed, for riskier countries. Until 2025, I estimated the mature market premium by computing an implied equity risk premium for the S&P 500, and using that as the base, arguing that the US, as a Aaa rated country (at least according to Moody's), represented a mature market. The Moody's downgrade for the US, from Aaa to Aa1, has thrown a wrench into that approach, requiring adaptation. In response, I now start with an estimate of the implied ERP for the S&P 500, but then adjust that estimate for the default spread (based on the Aa1 rating) for the US, with the resulting values at the start of July 2026 below:

Spreadsheet: https://pages.stern.nyu.edu/~adamodar/pc/implprem/ERPJuly26.xlsx

As you can see, with the S&P 500 at 7499.36 on July 1, 2026, the implied equity risk premium for the United States is 4.42%, and netting out the default spread of 0.22% for the Aa1 rating yields a mature market premium of 4.20%.

    To estimate country risk premiums, I start with the sovereign ratings for rated countries and convert those ratings into default spreads. To adjust for the higher risk associated with equities, relative to government bonds, I estimate a composite measure of that relative risk, by scaling the volatility in an emerging market equity index to the volatility in a emerging market government bond ETF, and scale the default risk up with this relative risk measure (1.55 in July 2026) to get country risk premiums:

For the two dozen countries that have no sovereign ratings, I adopt an even more makeshift approach, where I used political risk scores for these countries, and then looked for rated countries with similar scores. The table below has equity and country risk premiums, by country, for all of the countries that I evaluated in July 2026:

Download data

I did post an earlier version of this table a couple of weeks ago, but the numbers that I reported reflected in incomplete update of sovereign default spreads, and this table (and the data on my webpage) now reflect the corrected (and lower) spreads. (As a solo act, I am deeply grateful for the checking that those who use my data do, and thankful when they point out mistakes that I have made.)

Company Exposure to Country Risk

    If you buy into my argument that every company has a narrative, and it is the narrative that drives its value, it is worth considering where country risk fits into that narrative. The answer, I believe, comes from looking at where the country in question falls in the life cycle:

The message from this life cycle view is a sobering one, especially for those analyzing companies that operate in very risky countries, since the narratives for these companies implicitly or explicitly incorporate a country risk component. You cannot value a Venezuelan company without taking a strong view about Venezuela, or even an Indian and Brazilian company without an India or Brazil country story underpinning value. In contrast, you may be able to value US and European companies, without explicitly considering the evolution of country risk in those parts of the world.

    When looking at an individual company, I believe that country risk exposure comes less from where the company is incorporated and more from where it operates. It is undeniable that companies around the world have substantial exposure outside their domestic markets, and that exposure has increased over time. In the graph below, I look at the revenue breakdown of companies in four indices - the S&P 500 (US), the FTSE 100 (UK), the Nikkei 225 (Japan) and the Sensex (India):

    

In every single index, companies that comprise that index get a significant portion of their revenues from outside the domestic market. Looking across sectors, exposure to foreign markets varies widely with technology companies often generating more than half of their revenues outside their domestic settings. I believe that equity risk premiums for companies should reflect exposure to foreign markets, though it is worth debating how best to weight that exposure - revenues work well for consumer product and service companies, production works better for natural resource companies and a mix of revenues and production may be the right choice for manufacturing companies:

With this framework, you can see why almost all analysts will confront country risk, sooner or later, no matter where they operate in the world and which companies they analyze. 

    For companies, country risk will also come into play when faced with capital budgeting decisions, where they need estimates of hurdle rates for individual projects, to decide where to invest. For a multinational operating in many businesses, the project cost of equity will have to then also reflect the business the project is in, in addition to country risk. Thus, the cost of equity for a Siemens Appliances for a project in India should reflect the beta for the appliance business, in addition to the country risk for India. In contrast, a Siemens power tool project in Hungary should be computed using the beta for an power tools project and the country risk for Hungary. It is also possible that country risk is not easy to isolate, if the production facilities are in one country but revenues are generated in another. If the Siemens appliance factory in India will be producing products that will be sold in Japan, should we be showing the country risk of India or Japan in the cost of equity calculation? The answer, as was the case in the earlier section on valuation, is that it depends on where the company sees risk coming from. If the risk is that production will be delayed or disrupted by political and economic risk in India, it is Indian country risk that should be looked at, but if the primary concern is that revenues in Japan will be volatile because of economic conditions there, it is Japanese country risk that matters more. If both risks are considerations, you should use a weighted average of Indian and Japanese country risk.

Currency Questions

    For some of you, it may seem odd that I have spent almost an entire post talking about country risk without bringing up currencies. The reason is simple. Currencies are measurement mechanisms, and while they may be affected by the same political and economic factors that drive country risk, they don't determine country risk and in my view, should not command risk premiums, on their own. 

    It is true that hurdle rates are affected by both the equity risk premiums that you estimate and the riskfree rate that you use, and that riskfree rates vary across currencies. In the figure below, I estimate riskfree rates in about 40 currencies, where a local-currency government bond rate is present, and I adjust that government bond rate for the default risk of the government in question:

When estimating the cost of equity for a Turkish project or company in Turkish lira, we start with a riskfree rate in excess of 20% and build on it, by adding equity risk premiums to it, but the cost of equity for the same project or company in Euros will begin with a riskfree rate close to 3% (the German Euro bond rate) and arrive at a much lower number. While this may sound farfetched, the value that you derive for the project or company should be the same using either currency, if you are consistent about estimating your cash flows in the same currency:

Since much or almost all of the differences in riskfree rates come from inflation differentials, matching the high Turkish lira discount rate with a high growth in cashflows in Turkish lira, and the low Euro discount rate with the low growth in cashflows estimated in Euros will yield results that are consistent.

    If you do want to estimate riskfree rates in currencies where there is either no local currency government bond that is traded or where you mistrust the government bond rate, because of light trading or government intervention, the fact that riskfree rate differences across currencies can be tied to differential inflation can be used for estimation; the riskfree rate in any currency can be computed from a base currency (dollar or Euro) riskfree rate and the difference in expected inflation between the local and base currencies:

Put simply, if the expected inflation rate and riskfree rate in US dollars are 2.5% and 4% respectively, and the expected inflation rate in Brazil is 10.5%, the riskfree rate in Brazilian reais should be roughly 12%. The implication of this approach is that currency pegs, when they do exist, will hold only if the inflation in the pegged currency matches or is close to the inflation in the index currency to which it is pegged. It is true that the estimates of riskfree rates will only be as good as the expected inflation rates that are embedded in the estimation, but the good news is that being wrong on expected inflation will be largely offsetting, since both your cashflows and your discount rates will be wrong in the same direction; if you underestimate expected inflation, you will underestimate (overestimate) your riskfree and hurdle rates, but you will also underestimate (overestimate) your expected growth rate in cash flows.

Conclusion

   One of the side effects of the rise of globalization is that there are fewer and fewer companies that are entirely local-country focused in both their revenues and production, and as a result, almost every business and investor is exposed to risk in other parts of the world. The problem with measuring country risk is that while its consequences are economic, it has its sources in history, politics and governance structures. The measures of country risk, whether they be entity-based like sovereign ratings, or market estimates like sovereign CDS spreads, reflect this interplay.

    I confess that I have made simplistic assumptions and cut corners in my attempt to estimate equity risk premiums, by country, and there will be individual countries, perhaps even your own, where you might disagree with my assessments. As I noted earlier, my estimation approach remains a work-in-progress and I am always open to suggestions on how to estimate these premiums better, but keep in mind that whatever those improvements may be, they will have to work across 180 countries. 

YouTube Video

Papers on country risk and equity risk premiums

1. Country Risk Premiums - The 2026 Edition (July 2026)
2. Equity Risk Premiums - The 2026 Edition (March 2026)

Data

1. Equity Risk Premiums, by country - July 2026
2. Implied Equity Risk Premiums for the S&P 500 (Annual since 1960 & Monthly since Sept 08)
3. Inflation-based riskfree rates, by currency - July 2026

Spreadsheet

1. Implied ERP for S&P 500 (July 2026)

SpaceX, OpenAI and Anthropic: The S&P 500 Inclusion Question and Investment Consequences!

     Over the last few weeks, attention has (rightly) been focused on three potentially trillion dollar companies all lined up to go public, and much of the discussion has been about what SpaceX, Anthropic and OpenAI are worth (and will be priced at). In parallel, there has been a debate about indices and index inclusion criteria, a usually bland topic, but one that has become heated on the questions of whether these new mega-cap additions to the market should be included in the S&P 500. While I remain open to arguments from both sides of this debate, much of it seems to come down on the side that the index should not include these companies, with different reasons offered. 

    I am skeptical, since I see a combination of hidden agendas and misguided views about investing behind each of the three groups that are most vehemently against inclusions. First, you have a cadre of active investors, many of whom have been left bruised by a losing battle that they have waged over the last two decades against passive investments (index funds and ETFs), who view inclusion in the index as a fait accompli, and present this as an added risk to passive investing that can be avoided by paying these professional money managers to avoid that risk. Second, you have investing experts and academics who claim to be looking out for for retail investors and retirees, and view including these big, money-losing companies in indices as dangerous for these small investors, partly because they may not be aware of their exposure and partly because they should not be investing in these types of companies. Third, you have politicians, normally not founts of investment wisdom, speaking out about how including these large companies in government pension funds will reward billionaires, who are the villains in their storylines. In this post, I will try to step back from the heat and try to cast some light on the question of index inclusion, starting with an understanding of how indices are constructed before moving on to the roles they perform in markets and ending with a discussion of whether and how inclusion of these companies will affect the passive versus active investing debate.

Index Construction - Inclusion, Weights and Returns

    Indices have been around almost as long as assets have been bought and sold in markets, but it is undeniable that the extraordinary growth of financial markets in the last few decades, across geographies and asset classes, has added rocket fuel both to the number of indices in existence as well as their visibility. But what is it that sets one index apart from another, and why do indices that purport to measure the same market sometimes move in different ways? To understand the answer to these questions, we need to deconstruct indices and see how they are put together:

• Constituents: The first and perhaps most critical determinant of an index are its constituents, and what determines their inclusion. Take, for instance, the S&P 500, which Standard & Poor's (its creator) describes as the "gauge of large-cap US equities", and is without doubt the most widely tracked and followed index in global markets.  As its name indicates, this index has five hundred of the largest market-cap companies listed and traded in the United States, with caveats on inclusion relating to listing age (listed at least a year), liquidity (measured by looking at shares that are available for investors to trade in the market, i.e., free float) and profitability (positive profits in the four quarters leading into the listing). There are local indices that exchanges (NYSE, NASDAQ), equity markets in other geographies (the Bovespa for Brazilian stocks and the Sensex for Indian stocks) and individual sectors or industries. Across asset classes, there are indices for fixed income, as well as for real estate, fine art and crypto currencies.
• Weights:  You can have two indices that contain the same companies that register very different results over time, depending on how these companies are weighted, with three common choices. The first is to weight every company in an index equally, with the benefit being simplicity, but the cost being that to the extent that companies in an index have very different sizes, the performance on an equally weighted index will not capture aggregate market performance, because it will be skewed towards smaller companies. The second, and one used by some older indices like the Dow 30, is price-weighting, where the companies with the highest price per share are weighted more than companies that have lower priced shares. I cannot think of a single redeeming quality to price weighting, since it measures very little of consequence, and suffers from breakdowns, right after stock splits. The third and most widely used mechanism for construction indices is market capitalization, with tweaks sometimes added on for float (traded shares). The S&P 500, as I noted earlier, uses market capitalization, based on free float, to weight companies and as a consequence, Meta punches in below its true weight, since the bulk of class B shares (which are voting shares held by Zuckerberg) are not counted, as does Walmart, where some family-controlled holdings are treated as non-traded.
• Index level mechanics: Once constructed, an index has to be measured, and to the extent that these indices are designed to capture market prices, the first step is creating a mechanism for converting market prices on the constituents to an index level. Consider, for instance, the S&P 500 which ended trading on June 15, 2026, at 7554.29, and relating that number to the market capitalization of the companies that make up the index. At close of trading on June 15, 2026, the cumulative float-adjusted market capitalization of the 500 companies in the index was $63,498.44 billion and the index units for the conversion can be computed as follows:

Index units = Index level / Float-adjusted market capitalization = 7554.29/ 63498.44 = 0.1190 

Note that there is no intuitive significance to the index units standing alone, but its movements over time can be an indicator of changes happening at companies, because of issuances and stock buybacks, as well as changes in index constituents. If asked to compute earnings or dividends on the S&P 500, these index units come into play again, when converting the aggregated dividends and earnings across all of the S&P 500 companies into index dividends and earnings. In 2025, for instance, the aggregated dollar dividends on the S&P 500 was $664.90 billion, and multiplying that value by the index units (0.1190) yields an index dividend of 79.12 for the year.    

• Price updating: While index levels are starting points, most investors track indices for changes in the index, with increasing stock prices translating into higher index values. Indices that track publicly traded stocks, like the S&P 500 and the Dow 30, should adjust instantaneously as the prices of their constituent companies change during the course of a trading day, making the index a real-time measure of market movements. Indices that capture only price changes miss the other component of returns on a stock, which is dividends, and constructing an index that incorporates dividends paid on a continuous basis does take work and requires assumptions about whether the dividends are reinvested in the index or extracted by investors. Though not as widely disseminated as the pure-price version, there is a  variant of the S&P 500 that computes the total return on the index, with dividends included. Indices of assets that are not continuously traded, most notably real estate (like the S&P Case-Shiller home price index), try to overcome the absence of price data on the assets by extrapolating from the pricing of the subset of assets that get traded, leading to noisier estimates for index value and lags in price adjustment.
• Index changes (inclusions and exclusions): Even the best constructed indices have to confront change and have mechanisms to deal with that change that are transparent and quick to put into practice. Some of that change will come from companies being removed from public markets, either because they are acquired, taken private or because of bankruptcy. Some change will be caused by new companies being listed on the market or some will be created by changes in market cap in companies that bring them into contention for inclusion in the index, either because the market cap has risen (making them large enough to qualify for a large cap index) or has dropped, removing them from large cap status. Since you do not want abrupt changes in the index level coming just from replacing a company with a low market cap with one with a much higher market cap, the adjustment has to come from changing the index units. Thus, assume that a company goes public with a trillion dollar market cap and that it will be replacing a company with a one-billion market cap, the adjusted index units for the S&P 500 will be as follows:

  Index units = Index level / Float-adjusted market capitalization + Market cap of added firm - Market cap of eliminated firm = 7554.29/ (63498.44+ 1000 -1) = 0.1171

  This will then percolate through into the index earnings and dividends estimates, for the index. Note that while the index level will be unchanged by the addition of the trillion dollar company, the other components that it brings with it, including higher growth and perhaps negative earnings, will alter the fundamentals of the index going forward. 

With these index mechanics in mind, it is quite clear that if S&P does include SpaceX, OpenAi and Anthropic in the S&P 500 index, the index will not change at the time of the replacement, but it will change the index fundamentally going forward, bringing in more risk, a near term hit to earnings and perhaps a long term increase in growth.

The Index End Game

    When indices were first created for markets, their primary purpose was to create composite measures of market performance, with a single number (the index value) capturing the performance of a much larger group of assets. Over time, though, the use of indices has expanded, first as proxies to assess the performance of active investors, to see whether they over or underperformed, and then as investment vehicles, with the advent and growth of index funds and ETFs. 

Measurement

    I started in equity markets in 1981, and at that time, indices were primarily measures of market performance. At the time, for most investors without intraday access to markets and without financial news channels, news of market performance, on most days, was a snippet on the evening news, where the anchor would mention the market's change during the day, usually using the Dow 30 as a stand in for the market. Indices continue to perform the measurement role, though our access to data has changed dramatically, with real time updates on our devices occurring all through the day. From the measurement perspective, it is worth looking back at index construction and looking for indices that best capture what you are trying to measure. The reason that the S&P 500 has acquired primacy is that while it includes only 500 companies in a US equity market that has almost 6000 publicly traded companies, the fact that these are the companies with the largest market capitalization means that the index represents more than 80% of the market capitalization of all US equities, and as a result, it is the single best proxy for aggregate equity market performance in the index. That said, a different framing of the measurement question can lead you to a different index choice. Thus, if you are trying to measure how the average US equity did during a period, you may be better served using an equal-weighted equity index for that measurement. 

Performance Evaluation

    Investors who trust professionals to manage their money, and pay them for their services, either as up-front entry fees or in annual management expenses,  are entitled to wonder whether they are receiving a compensatory benefit, in the form of higher returns. It should not be surprising that comparing a mutual fund's returns to the returns on an index becomes a proxy for fund performance, and in the early years of performance evaluation, the S&P 500 became the default comparison index. Used in that context, one of the most jarring numbers in active investing is the percentage of active large cap funds that earn returns that are lower than the S&P 500, each year for the last two decades:

S&P Global

Over the last twenty five years, there have been three years where more than 50% of active funds have beaten the S&P 500 index, and barely so, and the extent of underperformance in the remaining years i staggering. The pushback from some active fund managers is that, given their investment styles, the S&P 500 is not the right index to use to judge them. Value fund managers, who invests in low-risk and high-dividend paying stock will argue that the portfolios they create are less risky than the S&P 500, making their lower returns more of a risk effect than underperformance. Academic studies that used risk and return models to tweak the index returns were quickly dismissed as being wrong, because the models that were used (the CAPM, the APM, Multi-factor models) were flawed. This deadlock was broken by S&P, when it created SPIVA, where the returns earned by fund managers in any class (small cap vs large cap, growth vs value, domestic vs foreign) are compared to returns that investors could have earned by investing in index funds in the same class, and by Morningstar, using a variant of the same approach. Thus, a fund manager who invested in small-cap, high dividend paying stocks would see his or her returns compares to the returns you would have earned on a small-cap, value index fund, making it much more difficult to explain away underperformance. There are many reasons for the slippage in active investing's share of overall investing in the last two decades, but the SPIVA results are devastating and damning for any claim of active investing superiority. Here, for instance, are the results, by investment class, on the percentage of active fund managers who underperfomed index funds in their investment style, over the last decade, at the end of 2025:

There is very little hope in these numbers, as fund managers underperform their respective indices in every single category, and by more, over longer periods. In fact, there is not a single fund group in any style that outperforms its respective index past ten years. For those of you who are reading this other geographies, and believing that it is different in your local markets, either because insiders have privileged access to information or market inefficiencies, SPIVA also tracks fund manager performance outside the United States, and reports similar results:

At this point, there is almost no counter to the argument that active investing collectively creates a drag on portfolio performance, and active investors seeking to defend the profession are left looking through the data entrails, hoping for niches where "alphas" exist. Thus, two decades ago, the notion that private equity investors and hedge funds were smarter than the market and could beat the market fueled a push of retirement and endowment money into these vehicles, but as they have become larger, they have come to resemble mutual funds, in terms of performance. 

Investing Vehicles

    There is a third use of indices that, in my view, has overwhelmed the measurement and performance evaluation roles that they play, and it is that they have become vehicles for investing in the form of index funds and exchange-traded funds (ETFs). That possibility was already existent in 1981, but at that time, the only index with an index fund available to most investors was the S&P 500. Today, you can not only invest in index funds across geographies, sectors or sub-groups based on fundamentals (including volatility, size and earnings), but the exchange traded fund explosion has given you an alternate route, with slightly higher costs (than index funds) and more liquidity. 

Vanguard, a pioneer when it listed the S&P 500 index fund in 1976, now lists more than a hundred ETFs and more than two hundred index funds, allowing investors to not only invest in almost any market, but also in the subsets (sectors, small companies etc.) that they chose to. The size of the index fund business and the fees its creates for the index creators has created some tensions in the process, and faced with a choice between a poorly constructed index that index fund investors would love to trade on and a better constructed one that investors find less attractive, it is possible and perhaps even likely that the fund creators will pick the former.

Indexing and Passive Investing - Unintended Consequences

    There are two forces that the last section highlight that have played out in altering financial markets structurally and dramatically in the last two decades. The first is that the underperformance of active investing has become easier to document and more visible for everyone to see. The second is that investors who see this underperformance have more passive investing vehicles in the form of index funds and ETFs accessible to them, and can move their money into them. As a consequence, in the battle between active and passive investing for investor dollars, the fight is getting so one-sided that, if you were a referee, you would invoke the mercy rule and try to stop it:

It is undeniable that the rise of passive investing vehicles has empowered investors, who have gained in terms of choice and costs, but it has also created an existential crisis for active investors, and especially so for those who make a living out of managing other people's money. While some active investors hold on to hope - that they are better than the rest, that this is a cycle that will reverse, that some new technology (big data, AI) will save them- there are others who have taken a different tack. Mostly conceding that index funds and ETFs have outperformed fund managers, they have taken to arguing that the rise of passive investing is creating costs and effects that outweigh its benefits, and that action is needed urgently, though it is unclear from whom. In this section, I will highlight three of those effects.

1. The Index Inclusion Boost

    The addition of a company to a well known or widely followed index (the S&P 500, Dow 30, MSCI Global) yields pluses, increasing its visibility to investors and potentially making it more investable, as well as increasing trading volume on the stock and making it more liquid. The question of how those benefits get priced in when a stock gets added to an index (and the costs of being removed from an index) have been studied over time, with a focus on additions to (and removals from) the S&P 500. As passive investing has grown, with more choices in index funds, it remains true that a significant percentage of passive investors hold S&P 500 index funds, and that, in the eyes of some, this should make inclusion in the S&P 500 index an even greater positive today than in decades past. 

    Looking across these studies, there seems to be a consensus that there is a bump up  in the stock price from a company being added to the S&P 500, and bump down, when a company is deleted from the index, but disagreements both about the magnitude of the bump and whether it is permanent and transitory. The general sense that you get from studies is that  bump in stock prices from being included in the index has become smaller and more transitory over time, and in the last decade or two decades, it has largely disappeared. To back this up, I look at one of the most complete studies that I have seen of the index inclusion question, where S&P took a look at the 715 companies added and 711 company deletions made to the S&P 500 between January 1995 and June 2021, and examine the excess returns in the days around the change:

Link to study

As you can see, the positiv eprice effects of being added to the S&P 500 index have depleted over time, as have the negative price effects of being removed from the index. Note that this finding cuts against the argument that as passive investing has increased in the last two decades, the allure of being in the S&P 500 should also have gone up. Instead, as the value of funds indexed to the S&P 500 has surged over the last two decades, the effect of being added to or taken out of the index has become smaller, not larger, and there is evidence accumulating that companies that get added to the S&P 500 are more likely to underperform than outperform in the twelve months after the addition.

    As the debate about whether SpaceX, OpenAI and Anthropic should be included in the S&P 500 index heats up, I would suggest that the evidence of a small and dissipating price effect of inclusion has to become part of the discussion. I am sure that there will be some who will disagree with me, but I don't think the price trajectories of any of these firms will be altered by whether they are included in or excluded from the S&P 500. For those who disagree with me, and believe that being added to index is bullish for investors in these companies, I would recommend that you look at the chart from this study which took a look at Tesla's stock price behavior before, during and after its replacement of Apartment Investment and Management (AIV) in the S&P 500 on December 18, 2020. 

Tesla not only under performed the S&P 500 in the months after its inclusion in the index, but massively underperformed the company (AIV) that it replaced in the index.

2. Momentum versus Fundamentals

    As the funds invested in index funds and ETFs has surged, the argument that some are making is that being added to an index gives you a boost, largely because of index fund flows to companies in that index, and more of a boost if you are a large cap company. Since the money flows from other stocks, this line of thought also suggests that fundamentals will receive less attention and disconnect more from prices, especially because there are fewer active investors doing research and looking for market inefficiencies. In addition, they note that since indices are mostly market cap weighted, this momentum benefits larger market cap companies, in effect allowing them to become larger. As evidence in favor of this argument, they point to the fact that markets have become top heavy, where a few winners are carrying the entire market, that the small cap premium, an enduring feature of equity markets in the twentieth century, has largely disappeared in this one and the dominance of momentum in investing success in the last decade.  I concede that these phenomena are consistent with the "passive investing feeds momentum" story, but I am skeptical that passive investing is the cause for the following reasons:

1. Momentum can cut in both directions: It is true that funds flowing into index funds flow into the companies in that index, with more flowing into large cap companies, but it is also true that funds can flow out of index funds, and when that happens, the momentum can cut in the other direction. In fact, the conclusion is that inclusion in a widely-tracked index (like the S&P 500) will increase intraday and short term volatility, but not price levels. In fact, the fading price bump from being added to the S&P 500 that we noted in the last section is an indication that the market does not buy into the momentum story.
2. Winner-take-all economics: If momentum is the reason for the big companies winning, there should be divergence between small and big companies on how fundamentals get priced. Put simply, you should see the pricing metrics (PE ratios, EV to EBITDA) for large cap companies increasing relative to small cap companies, as passive investing surges. Looking back at the fading small cap effect and top-heavy markets of the last decade or two, I would note that not all large cap companies have been winners, and the winning large cap companies have delivered a disproportionate portion of increased earnings. In the context of the Mag Seven, I have talked about how technology and disruption has changed more industries into winner-take-all businesses, with a few companies dominating these businesses, and why that phenomenon will play out in markets as well.
3. Active investing and equity research: In my view, the notion that most analysts and active investors are looking for market inefficiencies and seeking out information strikes me as misplaced. Much of active investing is built around publicly available information and a belief in the power of mean reversion, not original research and seeking information. It is true that there is a subset of active investors and equity research analysts who contribute to making prices more informative, but that subset is a small one, and one that is better equipped to survive the passive investing shift.

Doomsday stories about how passive investing is making markets less efficient and less inclined to reflect fundamentals strike me as overwrought, and while active investing will continue to lose market share, and deservedly so, it will not disappear. Since these stories are often being told by fund managers who not so long ago spoke contemptuously about efficient markets as an academic fever dream, they also strike me as both hypocritical and self-serving. 

    Even if you accept the argument that passive investing is making markets less efficient and more momentum-driven is true, I am unsure about the implications for investing. Asking individual investors, retirees and endowment funds to  pay fees to professionals to manage their money while underperforming indices, in service to the larger cause of market efficiency is tone deaf and a non-starter. In fact, any endowment or pension fund manager who uses this argument to steer endowment funds to active money managers would be in violation of his or her fiduciary responsibility. Perhaps, the argument is being made to regulators to restrict index funds (on which indices they can index, how much money they can manage), I can see why active money managers may be in favor, because I understand that they are trying to protect their livelihood, but they should dispense with any talk about protecting individual investors or making markets more efficient.

3. Hidden risks

    An undercurrent in some of the opinion pieces that I have read about why SpaceX should not be included in the S&P 500, written by investment experts and academics, is that it will expose retail investors and retirees to risks that they are unaware they are taking, or even if made aware of the fact, should not be taking in the first place. In particular, these opinion-writers seem to be arguing that the risks associated with investing in a big, money-losing companies (like SpaceX, and presumably OpenAI and Anthropic, when they go public) are so large that individual investors and retirees would not invest in these companies, and even they would, they should not be allowed to do so. I find this chain of reasoning to be both misguided and condescending, and reflective of misconceptions that are deeply and widely held in the investment expert class:

1. Risk and Diversification: Is it true that individual investors, if made aware of the companies that they owned in index funds, would blanch at the risks that they have exposed to in individual holdings? Investing just in a portfolio of a few companies like SpaceX would be imprudent, but an investor in a S&P 500 index fund is far less exposed to underperforming the market than the typical active money manager who either over invests in SpaceX (if it goes down) or chooses not to invest in it (if it goes up). 
2. Smart and Stupid Money: While the investment experts and academics who push to protect retail investors and retirees from their own mistakes will never put into words this belief, implicit in this push is the view that these small investors are uninformed and naive, and will be exploited by smart money (institutional investors and hedge funds). The notion that the smart money will know whether SpaceX (and companies like it) is overvalued or under valued, and is positioned to time investments better is fanciful, since institutional investors are more traders than investors, making them market followers, not leader.  
3. Good businesses and good investments: The weakest link in the argument against putting your money in money-losing companies is the implicit belief that money-making companies are good (safe) investments and that money-losing companies are bad (risky) ones. I will wager than an investor who was constrained to invest only in money-making businesses in the last two decades would have under performed an investor operating without those constraints, even after adjusting for risk. At the right price, a money-losing company can be a good investment and at the wrong price, a company with solid and stable profits can be a bad investment. 

I am generally skeptical of attempts to protect individual or retail investors from their own mistakes and decisions, since more damage has been done to this group by those claiming try to help and protect them over time than by those who are out to exploit them.

Conclusion

    In the week prior to the SpaceX IPO, S&P removed some of the suspense in the question of whether the company would be included in the index by announcing that they would stick with their requirement that a company be listed and traded at least a year before becoming eligible for index inclusion. That decision also means that OpenAI and Anthropic, if they do go public this year, will also have to wait a year for consideration. I am glad that S&P is not changing the rules to allow these companies to jump the queue to get into the index, but I hope that it is not framed as a decision that was taken to protect investors or in the hope that these companies would become magically money making, better governed and with working business models. The truth is that a year after they list and start trading, these three companies will still be money losing businesses, with business models that are still works in progress and will remain corporate governance horror stories.  S&P needs the time to manage the transition of three trillion-dollar companies into the index, even as it confronts the challenge of claiming to be a large cap index that does not include three of the largest market cap stocks in the market. As for the companies (SpaceX, OpenAI and Anthropic), I will wager that they will lose little in market momentum from not being included in the index, and that their price paths will be determined by how the AI story continues to play out in terms of both substance (growth, unit economics, reinvestment) and perception (hype and momentum). The bottom line is that S&P needs these companies in its index more than they need to be in the index, with the consequence that the companies will not go out of their way to meet index requirements that they feel are costly to them, and that if there is any bending, it will be S&P that does it.

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Revisiting the SpaceX Valuation: A Post-Prospectus Update!

     A few weeks ago, I assessed the value of SpaceX ahead of its initial public offering, with the admission that I was making my estimates with drabs of data, some of it coming from unofficial sources. I also promised to revisit my valuation, when the prospectus came out, and now that it has, I will examine how the information it contains has changed my view of the company and its valuation. I will also use this post to talk about the information gained by having access to a company's financials, and why the information you glean from those financials is different at younger companies, with growth potential, relative to mature companies.

The Prospectus: Data versus Information

    The requirement that companies that plan to go public in the United States have to register with the Securities Exchange Commission (SEC) and file a prospectus has been in place for decades, but the contents have changed over time, with disclosures added on partly by regulation and partly in response to investor demands. In a paper focusing on IPO disclosures from a couple of years ago, I noted that prospectuses have become more bloated over time, often running four to five times longer than those filed by companies that went public three or four decades ago, but not necessarily more informative. The SpaceX prospectus that we made public on May 20, 2026, is 277 pages long, with an addendum that runs another 100 pages, with dozens of pictures (mostly of spaceships going into orbit), a soaring story, but with weak links and multiple distractions. To get a measure of how the prospectus changes my pre-prospectus story and valuation, I will start with the easy part of the update, where I use the numbers from the financial statements in the prospectus to replace my pre-prospectus estimates, on operating metrics like revenues and earnings as well as on share count and IPO proceeds. I will then move on to the weightier part of the analysis, where I assess how the information in the prospectus has changed my story line and value for the company. 

The Prospectus: Data update

    In my pre-prospectus valuation, where I assessed the value of SpaceX at roughly $1.2 trillion, I relied on scraps of information, including leaked stories of estimated revenues ($15.5 billion) and EBITDA of $8 billion, since I did not have access to the company's full financial statements. With the release of the prospectus, that shortcoming has been remedied, and I started by updating the operating metrics that drive the intrinsic value of the company:

SpaceX prospectus

As you can see, my estimates for revenues for the launch and connectivity (Starlink) businesses were close to the actual numbers, but my xAI revenue estimates were much lower than reported. Overall, I had estimated an operating loss of $2 billion in 2025, and the prospectus yielded a larger loss of $2.57 billion. With almost $2 billion in interest expenses, unavailable prior to the prospectus, incorporated, the company reported a net loss of about $5 billion. A big factor in the operating losses reported by the company were its ballooning R&D expenses, and in keeping with my argument that these expenses should be capitalized, I estimated an earnings before interest, taxes and R&D of $4 billion.

    On the financing front, the prospectus filled in details on cash and debt that were unavailable prior to the prospectus being made public:

SpaceX prospectus

My pre-prospectus estimate of book value of equity was a shot in the dark, at $20 billion, but the acquisition of xAI caused that number to jump to $41.3 billion, as did the total debt (inclusive of leases) to $22.9 billion. The former (book value of equity) played little role in my valuation, but ignoring debt of this magnitude may seem monumental, there are two offsetting factors that reduce the impact on my value estimate. The first is that I also ignored the presence of cash, and with $24.7 billion in cash, the company's net debt is −$1.9 billion (cash exceeds debt), making the impact on value minimal. The second is that with my estimate enterprise value of $1.21 trillion, the debt, even if considered in full, is small enough to represent rounding error.

    The prospectus did contain information on share count and structure, as well as on the company's plans for the proceeds, and both were useful at the margin, with the former affecting my estimated value per share and the latter determining the treatment of the cash that will be raised from the offering:

• Share count: In my initial valuation, I used the private company pricing per share in conjunction with estimated market cap to back out a share count of 2467 million shares. With the prospectus, we get a clearer sense of shares outstanding, with a basic share count of 12,535 million shares reported in the prospectus (pages 246 & 247) in computing per share numbers. That share count does not include the new shares that will be issued in the offering, but that share count will be determined by the magnitude of the offering as well as the expected issuance price, and while the total share count includes options, warrants and rights that are exercisable before June 30, it does not include restricted stock units held by employees (see prospectus, page 18) and that information is still blanked out in the prospectus. 
• Use of proceeds: It is estimated that SpaceX plans to raise $75 billion from the offering, and the prospectus specifies that the company plans to hold the proceeds to cover infrastructure investments in these businesses (see prospectus, page 66). That implies that any money raised in the offering will add to the company's cash balance, right after the offering, and will augment firm value (but not enterprise value). 

The prospectus also lays bare the governance questions that will overhang the firm, with information that there will be two classes of shares- 6,932 million class A shares with one vote per share and 5,602 million class B shares with ten votes per share. The public offering will be class A shares, and with Elon Musk holding all of the class B shares, he will control more than 85% of the voting rights in the company. In summary, the prospectus is long and filled with distractions, but there is almost nothing in it that surprises me. SpaceX is a growing company that is money-losing and cash-burning, that will be a Elon Musk vehicle (with all the pluses and minuses that entails). 

The Prospectus: Story update

    In my original post, I noted that SpaceX is a company, where it is the story about how its businesses will evolve over time that drives value, rather than the base year numbers (on revenues, earnings and cash flows). That story, broadly speaking, has three key spokes to it and they are summarized below:

The first of these spokes, target revenues, frame how big each business can grow over time, and is a function of the total market and market share. The second, the target operating margin, will capture how profitable each business can become, and is determined by unit economics and economies of scale. The third, reinvestment, measures how much each business has to invest to get to target revenues, and will vary with the capital intensity of the business. To frame how my valuation will change, as a result of what I learned from looking at the prospectus, I will start by presenting by pre-prospectus estimates on these key inputs, and then look at the impact of the prospectus on each input.

Pre-prospectus inputs and value

    My pre-prospectus valuation of SpaceX contains my storyline for the three businesses that the company is in, with an add-on for the expansion options embedded in each business:

With these inputs in place, I estimated a value of $1.2 trillion the SpaceX enterprise, and since I ignored cash and debt, this yielded an equivalent market value. Driving these numbers are upbeat stories about each of the three businesses that SpaceX is in, with large revenues and high margins in stable growth.

The Prospectus Effect

    To the extent that the prospectus contains information that alters the storylines on any or all of these businesses, it will affect my estimate of value for SpaceX.

1. Revenue Growth (Target Revenues)

    I will start with the growth (target revenues) input and use two parts of the prospectus to reexamine my story. The first is the historical growth reported by the company for each of its three business lines - launch, connectivity and AI.

As you can see, the company saw its revenues grow by a third in 2025, relative to 2024, with divergence across businesses; the connectivity business led with revenues growing by almost 50%, the AI business saw an increase in revenues of about 22% but the space business reported only modest growth in the year (7.64%). In short, notwithstanding the star role played by AI and the appeal of the rockets in the space launch business, it is Starlink that carried the company in 2025. The prospectus mentions Colossus, xAI's compute center, which has been leased to Anthropic for an eye-popping $1.25 billion a month, which should kickstart revenues next year, with the potential of tension in future years if xAI plans to go head-to-head against Anthropic in the AI products market.

    The other relevant section of the prospectus contained estimates of total addressable market (TAM) for the company, broken down by business:

If the prospectus is to be believed, SpaceX has the largest TAM of any company in history, with a total TAM of $28 trillion, and AI accounts for $26 trillion of that market estimate. This estimate borders on fantasy, but I will cut the bankers who came up with these numbers some slack for two reasons. First, the estimation of TAM has been gamified by Silicon Valley, with bloated and patently unreachable numbers floated for companies, as I noted when I valued Uber (which was given a TAM of $5.7 trillion in its prospectus) for its IPO in 2019 and Airbnb (with a TAM of $3.4 trillion in its prospectus) in 2020.  Second, it is true that AI agents are usable across almost every business and geography, giving it much wider reach than most products and services, and while the details of how the TAM was estimated are not specified in the prospectus, my guess is that the $26 trillion estimate includes all or most of the operating expenses of all businesses. 

Story takeaway: I will stick with my estimates for target markets for the space launch and connectivity businesses, since the TAMs in the prospectus are, in my view, over reaches, and I will slow growth in the near years, to reflect that these businesses will take time to mature. In the AI business, I disagree with the magnitude of the TAM in the prospectus, but the acquisition of Cursor and the indications in the prospectus suggest that xAI very much wants to be part of the enterprise solutions space, notwithstanding its immense capitalization needs, and I will double my target revenues for AI from $80 billion to $160 billion, reflecting my estimate of a TAM of about $3 trillion to $4 trillion for AI products and services from businesses.

2. Profitability

     On the profitability front, the first part of the prospectus that I looked at was its breakdown of income statements, by business:

With the caveat that we have only two years of detailed information, there are interesting findings that emerge from the historical data on each of the businesses. 

• The space business has the best unit economics of the three business, with a gross margin of about 67%, reflecting the cost advantages of its reusable rocket technology. While the space business reported an operating loss, that was entirely because of its weighty R&D expenses, and capitalizing those expenses results in a healthy operating margin for the business.
• The connectivity business does not have gross margins as high as the space business, but those gross margins are improving, with gross margins jumping from 37% in 2024 to 48% in 2025. This business had positive operating income in 2025, even before capitalizing R&D, and improves substantially with capitalization. 
• The AI business not only has the lowest gross margins of the three businesses, but saw deterioration of those margins in 2025, reflecting intense competition from other LLMs as well as the rising costs of delivering AI products and services.

There are other parts of the prospectus that come into play in the profitability discussion, with each of the businesses:

• On the space launch business, the cost of launching payloads at SpaceX have been trending down, making its already large cost advantages in the business even larger. 
• On the connectivity businesses, there is bad news and good news on the per user front. The bad news is that the revenues, per month, per subscriber, declined from $99 in monthly revenues in 2024 to $66 in monthly revenues in the first quarter of 2026. The good news is that the number of subscribers has doubled from 5 million in the first quarter of 2025 to 10.3 million in the first quarter of 2026, with the bonus that the company has been able to improve its profitability (see gross margins in the table above) over time. 
• On the AI business, there is not much to go on, on the profitability front, since the focus in the prospectus is more on the increase in compute capacity (see nameplate compute draw on Page 90 of the prospectus) than it is on revenues, especially on the enterprise front. Here again, though, the Colossus lease with Anthropic should help with profitability in the near term.

Story takeaway: The unit economics for the space businesses, in conjunction with the recognition that there are no other substantial operating expenses (outside of the misclassified R&D expense) in either business, lead me to increase my estimate of the target margin for the business to 45%, from 40%. I will leave intact the target margin of 60% for the connectivity business, because once the satellites that service this business are in space, this is the business that will benefit the most from scale. My biggest shift is in my estimated target margin is for the AI business, where the dynamics that are pushing gross margins down, i.e., increased competition and high costs of delivering AI services, will persist; my estimated operating margin drops from 45% to 25%.

3.  Reinvestment

    In my post prior to accessing the prospectus, I did describe SpaceX as a capital intensive business, but the actual spending on capital expenditures and R&D in the prospectus is breathtaking in its magnitude:

In 2025, the company spent almost $14 billion in capital expenditures and almost $9 billion in R&D, a doubling of its reinvestment from 2024. In particular, it is AI that is driving the bulk of this surge, accounting for more than $14 billion in total reinvestment in 2025, with $9.1 billion in capital expenditures and $5.1 billion in R&D. The positive twist that a SpaceX optimist would put on these numbers is that the spending on AI in particular is a positive, indicating that the company is not planning to settle on a niche market strategy, but instead will will go head-to-head with Anthropic, Google and OpenAI for the enterprise solutions markets. The negative spin is that this ambitious agenda will translate into tens of billions more in capital expenditures in the near years, creating a drag on the cash flows and value destruction if they lose the AI market competition.

Story takeaway: Given that SpaceX is continuing to invest substantial amounts in its space launch and connectivity businesses, I will increase reinvestment in the near term (years 1-5) by lowering how much they will generate as additional revenues for every additional dollar of capital invested (lower sales to capital ratios). With AI, where I was already assuming that reinvestment would be large (with a low sales to capital ratio), the tripling of target revenues will result in a surge in reinvestment to generate the higher sales.

Updating Story and Value

    While the core story of SpaceX being a company with growth potential and strong competitive advantages that I framed prior to reading the prospectus remains intact, there are changes to that story that come from the information in the prospectus. The prospectus reinforces the notions that the company is best positioned in the connectivity business to generate both revenue growth and profits in the near term, that its cost advantages in the space launch business will persist and deliver profits, but that target market will be slower to develop, and that the AI business has both the largest target market and poses the biggest challenges, in terms of profitability and capital intensity, for SpaceX. 

    Bringing together my changes in target revenues, operating margins and reinvestment inputs allows for an update of the input table that I started this section with:

Clearly, some of the changes in inputs (such as the higher margins for the space launch business and a bigger target market for AI) will push value higher, and some of the inputs (including a slowing of near term growth for all business, and the much lower margin for the AI business) will push in the opposite direction. Since US treasury rates have risen from 4.20% at the time of my earlier valuation to 4.56% at the start of June, I have increased the costs of capital that I use in the valuation accordingly (to 8.37% from 8.02% to start the valuation, and the steady state cost of capital to 8.25% from 8.00%; both numbers would put SpaceX at close to the median for all US companies). With these updated inputs, I reestimate the cash flows and the valuation for SpaceX, with the IPO proceeds (estimated at $75 billion) added to the mix: 

Download spreadsheet

The enterprise value for SpaceX edges up from $1.21 trillion, in my pre-prospectus valuation, to $1.22 trillion with the post-prospectus numbers, and the overall equity value increases to $1.3 trillion, with almost all of the increase coming from the influx of $75 billion in cash from the IPO, albeit with a higher share count. The value per share of about $100 will need some revisiting as the IPO numbers firm up and more information is forthcoming on restricted stock units owned by employees, but just as I was finishing this post, a news story hit the wires that the offering price would be set at $135/share.

   If I were to summarize the impact of the prospectus on my SpaceX story, it would be that it has made the story bigger, but also more volatile. There are a multitude of risks that SpaceX faces in each of its businesses, but the one that I would be concerned about the most is that it will overreach in the AI business, beginning with an overestimate of the target market for AI products and services and the strength of its own competitive position in that market, and following through with investments that reflect those misplaced assessments. Those concerns are heightened  by a voting share structure that locks in Elon Musk's control of the company, since there is little that shareholders can do to restrain the company, if SpaceX doubles down on capital expenditures and acquisitions in the AI space, even after it becomes clear that the AI market is much smaller than anticipated and/or that xAI's offerings are not as good as the competition. If you add to this mix the antipathy that exists between Musk and Sam Altman, you have the potential for a UFC match between two monstrous egos, funded by tens of billions of dollars shareholder money.

Financial Statements and Value: The Life Cycle Effect

    Financial analysis and valuation, going back to Ben Graham's Security Analysis, has always been centered on financial statements, and that focus has become more intense over the last few decades as access to data and analysis tools has expanded. In fact, much of what passes for valuation has become financial modeling, where line items in financial statements are forecast based upon the historical time series, with the proverbial bottom lines being earnings and cash flows. Along the way, ratios computed from financial statement numbers are used to screen companies for investment quality. Some of these ratios, such as accounting returns on capital and equity, have become the basis for assessing company quality and competitive moats in the hands of consultants and investors. The SpaceX prospectus is a case study in why this approach to investing is often myopic and misleading, and why the informational value of financial statements will change as companies grow and mature. 

    In valuing companies, you are always trying to forecast revenues, profits and cash flows in future, but they key questions you want answered and the drivers of value shift as you move through the life cycle:

As you can see, for young companies, the key determinants of value include sizing the total market and assessing unit economics, and not the proverbial bottom lines in accounting statements including the magnitude of revenues and profitability. As companies move through the life cycle from start-up to mature to decline, you should expect to see financial statements evolve as well. Young and high growth companies will generally report small revenues (though they expect those revenues to ramp up over time) and losing money and having negative cash flows is a feature, not a bug. As companies mature, revenues will get larger (albeit with lower growth) and profits turn positive, as will free cash flows available to return to shareholders in dividends and buybacks.

If you allow for the fact that all three of SpaceX's businesses are young, falling in the young to high growth categories, the big questions driving value are about market size and unit economics, since the former provides the basis for revenue growth and the latter determines profitability. That is why, when looking at the prospectus for SpaceX it was the data on total addressable markets, unit economics and capital intensity that had a bigger impact on value, and this information, for the most part, was in the footnotes to the financials, rather than in the financial statements themselves.

    For those who are focused on value metrics/constraints (consistently money making, high profit margins and accounting returns)  and pricing multiples (low EV to EBITDA or low PE), the SpaceX prospectus is full of red flags. SpaceX is a company with small revenues and large losses, and paying a hundred times revenues for it (which is where a $1.8 trillion pricing would put it) seems foolhardy. I have no quarrels with this point of view, which animates old-time value investing, but this perspective comes with a cost in terms of investment choices. Investors who are wedded to never buying money losing companies or never paying more than twenty times earnings for a stock will end up with portfolios of mature (and declining) businesses. If that is their comfort zone, the strategy is perfectly defensible, but they should dispense with complaints about never being able to find high growth stocks to invest in or critiques of others who find these stocks attractive, notwithstanding the weak numbers. 

    There are many good arguments that can be made about why you should not invest in SpaceX, but basing that conclusion on the fact that they are money-losing or have negative cash flows or trade at a high multiple of revenues is both lazy and unconvincing. In contrast, making a case against investing in SpaceX because you believe that the target markets for its businesses will be far smaller than the company thinks they will be, or that cost and competitive pressures will drive margins down or even that you find its corporate governance structure and dependence on a personality (Elon Musk) off-putting is perfectly reasonable. If you do make that case, though, it is worth remembering that this is your point of view, and that disagreements about market size and profitability across investors, especially in young companies, are natural and healthy. In short, based on my inputs and story, I think that SpaceX is worth about $1.25-$1.3 trillion, but if you contend that it is worth $3 trillion or only half a trillion, it is neither my job nor my place to convince you that I am right and that you are wrong. 

The IPO Pricing Game

    In the coming weeks, you will undoubtedly be exposed to multiple perspectives on SpaceX, and that is healthy. That said, you will be better equipped to make sense of these perspectives, and perhaps incorporate some of the views into your own, and reject those that do not make sense, if you have an understanding of what an IPO process involves. In particular, understanding the motivations of the different players in the game (the investment bankers setting the offering price and managing the offering,  the issuing company, the investors and traders jockeying for shares at that offering price and the traders positioning themselves for the first day of trading) will help determine whether you should be playing this game or sitting it out, at least for the moment.

The Bankers

    Let's start with the sequencing that goes into a conventional initial public offering, though alternatives have emerged to it in recent years:

As you look at the role played by bankers to the IPO process, allowing them to keep a  slice of the IPO proceeds, the SpaceX IPO is a testimonial to the dwindling value added by bankers on every dimension:

1. Timing: It is urban (or market) legend that investment banks can time markets, and that this market timing can help determine the best time to go public. Just one look at the track record of market strategists at investment banks should dispense with this delusion, since banks (and most institutional investors) are (and have never been) good at gauging market momentum and shifts in mood. 
2. Filing and Offering details: It is true that there are technical details and logistical steps to filing a prospectus and setting offering details, but they are almost all mechanical. With SpaceX, I am not sure whether the prospectus, as filed, was the work of a team of bankers, but if it was, I wonder what an entirely Grok-written prospectus would have looked like, and whether we would have noticed the difference. 
3. Pricing: In an IPO, the bankers' mission is to price companies for their offering, not value them, and while they usually draw on pricing multiples and peer groups to make that pricing judgment, they are guided by the pricing in the most recent private transactions, usually in the form on venture capital rounds. With SpaceX, that task is simplified by the reality that this company, while private, has had active trading in its private shares, and that it was priced at roughly $1.2 trillion prior to the IPO process commencing. Adding the $75 billion in offering proceeds, and incorporating the advantages of increased liquidity from being a public company and becoming part of the S&P 500, it is not surprising that there is a sense that the offering will be priced at between $1.5 trillion to $2 trillion, with or without the investment banking input. My guess is that we will end up somewhere in the middle, with some handwaving about revenue multiples and other AI companies used to justify that pricing. (After I finished this post, a news story popped up that the offer price would be set at $135/share, translating into about a $1.8 trillion pricing for the company.)
4. Selling/Marketing: In an age where investment banks have lost credibility and social media is where marketing happens, SpaceX can generate its own marketing spin, and has an army of influencers behind it. In addition, almost every institutional investor has a point of view on whether to own SpaceX or not, it is unclear what exactly a roadyshow can do to augment the sales pitch.
5. Price guarantee: The pricing guarantee that investment bankers offer in initial public offerings is a mostly empty promise, since they systematically set offering prices at below (by 15-20%) what they believe the market will pay. That is the reason that the offer price for SpaceX will be set below the upper end of the range, and while the discount may seem like a significant loss to funders and current owners, the fact that the offering is for less than a tenth of the shares in the company will soften the blow.
6. Post-market support:  As a follow-up to the price guarantee, investment banks often offer after-market support for companies in the days after they go public, buying shares if the stock comes under selling pressure. With SpaceX, that option is off the table, since no investment bank has the capital to support the pricing of a two-trillion company, if investors turn negative on it.

In fact, given that banks are perhaps getting more from the initial public offering, in terms of publicity and allotments for their preferred clientele, than SpaceX is getting from their services, you could argue that the bankers should be paying the company for reflected glory, rather than charging them fees. The only good reason that I can think of for SpaceX not going the direct listing route, where you dispense with the kabuki dance of offerings and let the market set the offering price, is that the company needs the cash from the offering, and that route is much more difficult to take in a direct listing.

Issuer (Company, Founder and Investors)

    Looking at the IPO from the SpaceX perspective, the public offering will provide benefits. For the investors in the company in its private form, including venture capitalists from early in its life to public investors in more recent years, the IPO will allow them to cash out, albeit after the lock-out period expires in a few months. For the company, the increased access to capital from being a public company will allow it to fund the capital expenditures and investment needs that emanate from the company's ambitions in the AI business. For Elon Musk, the public offering has the potential to make him the first trillionaire in history, in addition to unlocking new pathways to further enrichment for meeting specified targets (including getting a million people on Mars).

   Since some of these benefits have been in existence for many years, the fact that company stayed private for that period is an indication that there are costs to going public that have held it back. The first is that, notwithstanding Musk's voting control of the company, become a public company will open SpaceX to market scrutiny, in the form of earnings reports every quarter and insider trading reports. The second is that the market is fickle, and while it is rewarding companies that invest in AI with high market prices today, it can change its mind and punish them for the same reason. The third is that while there is little that investors can do to trade and make money on overpriced private businesses, they can sell short on public companies.

Investors and Traders

    SpaceX is a company that has been in the public eye for a decade or more, even as a privately owned enterprise, partly because of its social media boosters and partly because its space launches make it a magnet for attention. There are many who are drawn to the company, but unable to invest in it as a private business, will now have a chance to do so, if it goes public. But should they try to partake in the initial offering? The answer to that question  depends on whether you are an investor, where you buy (sell) companies that you believe are trading under (over) their assessment of value and hope the gap closes or a trader, where you buy (sell) companies where you expect prices to go up (down) in the future, for a multitude of reasons, only some of which may relate to company fundamentals.

    I am more investor than trader, and I say that without judgment, since the end game in markets is to make money, not score intellectual points. The truth is that I am not a very good trader, and I am better off staying in my preferred domain, which is valuation, albeit with no guarantees of a payoff.  My valuation of SpaceX was driven by my interest in the company and belief that it is in unique, cutting-edge businesses, and my decision on whether to buy into the offering is therefore driven by my assessment of its value. At the rumored pricing of $1.8 trillion for the company, it is too richly priced for my tastes, given my valuation of $1.25-$1.35 trillion for the equity in the company. That does not mean that I will never buy the stock, since the market does change its mind, and if the price does drop by enough, my decision would change accordingly. It is worth remembering that Facebook was selling at half its offering price a few months after its IPO, and that Uber lost more than 50% of its market cap in the year after its public offering, moving both companies from over to under valued.

    If you are a trader, though, the game changes. Specifically, the intrinsic value of the company is not central to your decision, perhaps even irrelevant, and your judgment on whether you seek to partake in the SpaceX offering will depend on your reading of market mood and momentum. I would not be surprised in the least to see the offering priced at $1.8 trillion, and see a jump in the price on the day of or in the weeks after the offering, and if that is your most likely scenario, being able to get into the offering at the offer price or even in the first few hours or days of trading will be a winning strategy. The risk, of course, is that momentum can shift quickly, causing a significant price drop, effectively making  timing your trades right key to your trading strategy. The shifting and often unpredictable forces of mood and momentum are also the reason that as an investor, I would not sell short, notwithstanding my value assessment, even if the pricing for the company pushes from $1.8 trillion to $2 trillion or more. 

A Loaded Bet on AI!

    As the IPO process for SpaceX heats up in the coming weeks, you should prepare yourself for a flood of selling from the company and its bankers, with talk of possibilities and potential dominating the discussion, as well as arguments from the other side, where it will be framed as a vehicle for AI hype, destined to fail. If you are on the receiving end of these sales pitches, you should listen but check the numbers for plausibility and make your own judgments. For the bankers involved and the issuing company, the biggest danger to a successful offering is not that there will be near-term reality checks on their hype, but that the market mood will shift, either in the aggregate or specifically related to AI, in the weeks leading up to the offering.  No matter what your views are about the SpaceX IPO, positive or negative, there is no denying that this company is a loaded bet on the AI  and Elon Musk, and while that may concern some, there are others who will look at Musk's track record with Tesla and feel the odds are in their favor. 

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Attachments

1. SpaceX prospectus
2. Valuation of SpaceX, post-prospectus on 6/2/26

Blog posts on SpaceX

1. To a Trillion(s) and Beyond: A SpaceX Odyssey!