Talking Stocks: Anybody Else Miss the $1000 Tesla Rise?
Updated: Sep 20, 2020
Aside from a) a stock price that’s gained over 130% this year and b) a CEO that loves rattling markets with a good tweet, there are very few certainties when it comes to Tesla Inc.
Its journey as a tech startup as well as an automobile manufacturer has been marred by controversy: with reiterated doubts on manufacturing, profitability and future growth imbued from all directions. In the past, this has - unsurprisingly - kept investors and their capital away from Tesla.
In the past.
The story today, including and especially the stock price, has a very different narrative. Via the triple-digit gains in its share price this year, the market’s consensus on this company seems to be profoundly optimistic...but should that really be the case?
Let's delve into why – contrary to convention – missing out on Tesla might’ve actually been a good thing instead.
1. Historical and Future Volatility
According to Barron’s, Tesla stock has boasted a 60% volatility ratio in the past year: meaning that 151 of the last 252 trading days have experienced heavy swings in the company’s stock price.
Figure 1: Tesla Performance vs. S&P500 (more fluctuations with the green line compared to the grey)
While such volatility would make day traders ecstatic– those who keep investing positions open for minutes/seconds and are experienced with violent swings – it’s plausibly less enjoyable for those newer to the game. In fact, most young investors – including myself – would testify to the dread of buying volatile stocks early on via the following chain of events. We:
a) were enticed by a company that quickly falls and then quickly rises;
b) proceeded to open an investing position on that particular stock;
c) felt stomachs turn inside out as volatility plunged our position into deep losses and then finally;
d) closed our losing position in panic.
A sobering cycle that naturally arises when newcomers and volatile stocks are paired together. I'll do you one better: what happens when we convert these actions into quantitative measures?
“After accounting for the small number of winning trades, it is estimated that volatile trading in the week of March 16th – March 24th cost new retail investors total losses of $234 million in Australia alone.” - The Guardian
In other words, new investors were grossly punished to the tune of a quarter billion dollars because they a) underestimated the risk of high volatility or b) overestimated their ability to ride out the storm.
Does this mean that beginner investors should never invest in Tesla? Absolutely not. But looking over those stunning figures again would say a thing or two about the importance of experience before targeting such volatile companies.
2. Sizeably overvalued stock
Relative to future cash flows, Tesla’s stock carries a hefty price tag: one that raises questions about the risk-reward of holding such shares.
Figure 2: Tesla Valuation
Source: Simply Wall Street
Even more so, in a market that’s fueled with signals of an impending crash, are overvalued stocks really the class of companies that beginners would benefit from holding? Probably not.
“We continue to believe TSLA is fundamentally overvalued, and call for a 65% plunge in the stock” – Brian Johnson, Barclays.
Alongside dear Brian mentioning the fundamental demerits of Tesla, there is still a potential opportunity to consider.
The company’s expensive stock price and therefore, its riskiness, tend to cause relatively larger drops in the event of a market crash. In other words, if the market went down 30%, we usually see Tesla drop even further (in fact, >50% in the most recent crash) as investors would naturally let go of the assets they feel less safe in.
This becomes significant when we see that such a rapid sell-off – historically – has caused Tesla stock to rest at levels far below its fair value. In fact, the price dropped to ~$350 per share in the March crash, which trails the fair value of $692 (shown above) by a substantial amount.
Bringing everything together, this suggests that:
a) In normal circumstances, beginner investors should avoid Tesla (given its volatility levels, which may be difficult to initially digest), but;
b) In the event of a large crash and investors having some experience under their belt, targeting Tesla has benefits because the margin of safety (after falling, how much the stock price can increase before reaching fair value) with Tesla is highly attractive in such situations.
To put it differently, missing this rise can be positively perceived when it comes to beginner investors. It exempted beginners from uncertain volatility and also showed them the exact conditions (after a market crash + high margin of safety) in which owning Tesla stock would be most lucrative. Win-win.
3. “Faith” Stock
The third and perhaps most interesting reason to steer clear of Tesla is the notion that it’s a “faith stock”: a company that mainly relies on the management team and its reputation for market movements.
Figure 3: Sales needed to justify Tesla rise
Financially, the company poses weak profitability and poor cash flow, which tends to overshadow the "bright" future of electric cars from an investing perspective. Competitively, the road also remains hazy: with BMW beginning their own line of electric vehicles, new player Nikola recently coming into the market, and fragile US-China relations harming Tesla’s dominance in the latter country.
When coupling these cited uncertainties with the astounding figure shown above, how on earth is a stock price pro-$1000 justifiable?
The answer is, it probably isn’t. Mere “faith” is what seems to be mainly propelling the stock today, suggesting that investors are more likely placing a bet on Elon Musk's genius as opposed to the company itself.
If this is the case, was missing out on Tesla's meteoric rise really a mistake? Buying into irrational exuberance versus listening to fundamental analysis...the choice is yours!