Tesla: if you can’t be right, be less wrong

A little less than a year ago I put up Tesla: hope is not a strategy and listed the five things that were putting the future of Tesla in doubt:

  1. Tesla closed most of its retail showrooms and laid off staff in order to save 6% of cost per Model 3 car sold.
  2. The Model 3 lost the Consumer Reports endorsement and was plagued by questions about quality and service wait times due to Musk’s “production hell”.
  3. A prediction by Musk of another quarterly loss.
  4. Musk’s continued run-ins with the SEC.
  5. And most damning of all: the possibility of slowing demand.

Tesla was a high-flying darling that people were having second thoughts about and it was reflected in its stock price. It was a solid candidate to short since it was burning cash, probably needed to raise capital, and their ability to deliver product was being questioned. However, after another quarterly loss in 2Q19 the company turned it around and posted a surprise profit in 3Q19, handily beating expectations of yet another loss.

With 4Q19 earnings just released earlier this week it appears that the turnaround at the company may be sustainable. Adjusted earnings per share increased to $2.14 from $2 a year ago while revenue rose 2 percent to $7.4B from $7.2B. More importantly, for the first time ever Tesla said production wouldn’t be a constraint on deliveries and they’ve started the production ramp of its Model Y, the crossover SUV, ahead of schedule.

Personally, I was hoping for a joke out of Musk about this being the first time he’s accomplished something he promised ahead of schedule, but alas.

And the demand issue from earlier in 2019? Apparently gone. Tesla delivered 367,500 vehicles in 2019, up from 50 percent a year ago and projected they would “comfortably” deliver more than 500,000 in 2020. While Musk made the comment that Tesla should be self-sustaining from a capital standpoint going forward with positive GAAP earnings and positive quarterly operating cash flow, the important part for Tesla is the continued growth in demand for its vehicles.

Trading vs Investing

Tesla is a great case study in trading versus investing. There were many people who shorted Tesla shares in 2019. Shorting a company is not an investment. It can never be an investment – only a trade. With an investment you’re only at risk of the price going to zero and you can easily mitigate the risk to your overall portfolio by using responsible position sizes. When you short a stock there is theoretically no cap to your potential loss outside of an unmet margin call and a forced liquidation by your broker.

Since your downside isn’t capped, it’s up to you to select an inflection point where you acknowledge you’re either wrong or the market is likely to stay “wrong” longer than you can stay solvent. The solution is to either select a predetermined stop loss or use a long-term moving average as your guide.

Look at the chart below that starts a month before when I posted about Tesla’s troubles last year:

2020.01.30 TSLA

During the three months after I posted it looked like my fundamental thesis was correct and enough market participants agreed with me to have the price continue to fall. From March 6 until May 31 the price was down ~33 percent, which is always a lovely gain for three months’ time.

However, it was at the end of May that the market decided Tesla wasn’t a lost cause and started bidding up the stock price yet again (HODL!). While the shorts obtained a brief victory towards the end of July, the stock continued its upward trajectory before exploding higher after 3Q19’s surprise profit.

For any trader who used the 200-day moving average (and there’s nothing special about this one – pick a number between 150 and 250 – the same concept applies), he would have exited his position on October 14th with a seven percent profit on the trade. More importantly, he wouldn’t have the ~132 percent loss he’d be sitting on today if he maintained his short the entire time.

Buy, Hold, Sell

Even after Tesla’s recent price and fundamental momentum there are still analysts that maintain a “Sell” rating on the stock. Garett Nelson, an analyst with CFRA, wasn’t convinced by the earnings and said in a note that “we continue to see risks related to the China factory ramp-up, as well as rising EV competition from auto makers still eligible for the full federal tax credit in the US … We view the stock’s current risk/reward as unfavorable at current levels and maintain a sell.” You might read a note like that and think you should short a stock. It’s misleading – the advice to sell the stock is if you already own it as the upside versus downside risk in not in your favor in Nelson’s opinion.

Shorting a high-momentum cult stock whose fundamentals appear to be improving is dangerous. Dan Ives of Wedbush captured Tesla’s likely short-term stock performance in his note when he wrote that quarterly performance was “impressive, with clear momentum looking ahead” and Tesla’s “bull party” is likely to continue.

You can have an opinion on whether the direction of a company’s fundamentals support the current price direction, but until enough other participants agree with you, you won’t make money trying to short it.

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