When I wrote a piece back in August that suggested that Tesla Motors (TSLA) may be a little overvalued given that they were losing money and had a forward price to earnings ratio of over 150, the reaction was swift, but not unexpected. Like Apple (AAPL), TSLA has many followers who love the product and are fanatical in their belief that everybody else should too. So, again as with AAPL, a negative article about the stock saw many true believers tell me that I had no idea what I was talking about.
Believe me, I appreciate and understand their devotion to the product. It is undoubtedly fantastic and, unless one has a vested interest in the status quo, it is hard not to root for a vehicle without emissions. That devotion, however, caused them to miss the point of what I wrote at the time. My quibble wasn’t with the product or the long term prospects of the company, it was with valuation and the growth expectations that they implied. In the medium term, it seemed to me, there was also a problem with battery supply that had to be overcome, but it was the ever growing expectations and a sense of an overbought market that worried me.
Yesterday, Tesla reported another spectacular quarter’s results by any normal metrics. They beat even those optimistic expectations on both the top and bottom line and, to my mind more importantly, CEO Elon Musk indicated that the battery issue was being addressed. They had reached an agreement for increased supply and were considering building a factory to produce their own lithium cells for the future. So with all this good news around, what happened? TSLA lost over 12% in afterhours trading to finish the day at $155.
This is the kind of thing that frustrates most individual investors enormously. While it is true that TSLA is still losing money, they did beat expectations handily and indicated a possible resolution to a supply issue, yet still the stock tanked… so why?
Partly it is down to a slight change in tone from the company. One of the people angered by my August article had an interesting reason for believing that TSLA would continue to rise. His argument was something along the lines of “…every time the momentum slows, Musk makes another announcement that pushes the stock back up…” Hmmm, to me, that was part of the problem; it seemed that management was encouraging ever growing expectations.
In many ways they were right to do so, but at some point exponential growth has to slow, and forward guidance in yesterday’s release was toned down somewhat. This has been quoted by most observers as the main reason for the stock’s big reaction to the downside. I am sure that was the catalyst for a drop, but the size of it is better explained by this…
The above is a one year chart for TSLA’s “days to cover,” a measure of the short interest in a stock. As you can see, the number of days it would take for all of the shorts out there to cover their positions has fallen dramatically. Because of the way the metric is calculated, this is partly to do with the increased trading volume, and partly the cost of shorting the stock, but nonetheless it is fairly obvious that the bears have been in retreat.
As I pointed out back in August, when it seems that everybody’s view is the same, investors should take care. The problem is that once a move starts (in this case, down) there is very little to stop it. Most short sellers are by nature fairly short term traders and their covering their positions will usually put the brakes on a stock once it starts sliding. Without that natural slowing mechanism, however, who is going to step in and buy?
On yesterday’s evidence, it seems that the answer to that is “very few people”. Ironically though, for me, this new era of restraint and reality from both management and investors is a positive for TSLA. I still wouldn’t be a buyer of the stock yet, but if selling continues and it is combined with a rise in short interest, then I will certainly look again.
Good investment ideas usually come from a combination of factors. Fundamental research into a company’s profits (or lack thereof) is important, as is a less tangible sense that a company has enormous potential. The reaction yesterday to Tesla’s earnings release, however, shows that investors who ignore the market dynamics and positioning of traders in a stock do so at their peril.