Well, folks, if anybody missed the tech bubble of 1999/2000 and wondered - in hindsight, of course - how people could have been gulping down the Kool-Aid, look no further than the current bubble that has been forming in shares of Tesla Motors (TSLA) over the last several months. This is what happens when you get a highly shorted stock that is blessed with a series of positive news events - a squeeze of epic, and irrational, proportion. So, what's an investor to do?
This Is A Bubble
I can't tell you when, but Tesla's shares will eventually crater - hard. While common sense tends to sound stupid when the tape continues to look healthy, it seems all too obvious in hindsight. This is a company that trades at 13.7x sales, has a decently healthy balance sheet ($750M cash, $593M in debt) only because the company recently issued a secondary in which the company sold 3.39M shares at a price of 92.24/share (who seemed to smile and nod through said dilution) by raising capital by selling equity, and whose bubble-chasing shareholders believe that posting $26M of non-GAAP net income is worth adding another few billion to the market cap.
Further, it's a little bit insane to think that Tesla - whose business is selling ultra-high end cars to a select few rich folks with more money than they know what to do with - is worth $18B on $1.32B of TTM sales, but General Motors (GM) - with revenue of $152B and a TAM that will always be significantly larger - is worth a mere $49B.
Any bystander given these numbers - without being told the names of the companies - would probably tell you that the former was probably way overvalued compared to the latter. But, see, that's not how the market works.
Right now, we're in a QE-induced bull market, and it seems that anything with any real short interest is being squeezed to some degree. Now, compound this natural tendency to squeeze shorts with the fact that Tesla has an interesting story with an equally interesting management team, and you get a stock that people will aggressively buy into. This, of course, triggers short covering, which further drives more momentum buying. The point is, a good deal of this move is simply due to market dynamics than to any underlying strength of the business that justifies this nosebleed valuation.
But, just as we saw recently with the bubble-chasers who blindly bought into the UniPixel (UNXL) story, as well as those who bought into the telecom equipment vendors back during the 2000-bubble, these things eventually come to an end as reality sets in. At some point, the news flow won't be all that rosy, and then all of the folks who have maxed out their margin credit cards to be long this stock will suddenly find themselves wanting to sell - at the same time. Now, compounding this dynamic will be the short sellers who will finally get it right and start sinking their teeth into this vastly overvalued bubble.
It's Just A Question Of Time
Don't short Tesla now - it's a fool's errand to try to short a well-loved momentum stock that still has a significant short interest. Believe me, I've been the guy trying to call the top on a momentum name and it usually turns out to be a rough ride (although I've never been electrified in the manner that Tesla shorts have been thus far). The time to start building a short position will be when the news flow starts to turn "less positive". Now I don't mean sell-side analysts getting onboard the negativity train - they are usually powerless when it comes to stocks like this [as folks who followed Goldman Sachs' (GS) recommendation painfully found out]. I mean, we've got to see some legitimate "bad news".
So, to understand what it would take to pop this bubble, let's go back and take a look at the UniPixel story, which looked a heck of a lot like the Tesla one:
UNXL data by YCharts
So, amusingly enough, "bubbles" follow pretty much the same trajectories as penny stock pump & dump schemes. So at first you have a stock that trades within a pretty narrow range that maybe some people have heard about, but it isn't widely known in the investment community. UniPixel fit that bill, and I'd argue that even Tesla fit that bill. Anyway, so what happens is that the stock goes up dramatically, and then you get a bunch of short sellers thinking that they're clever and try to call the top on a "bubble" (since the underlying businesses are usually not all that great). Sometimes they're right, but often they're dead wrong and then the shorts get squeezed, sending the stock to new highs.
Then, of course, after the "smart guy" shorts have been largely squeezed out, the stock has a little more juice until whatever thesis that was propelling the shares to new highs doesn't pan out as planned. Everybody who bought the stock high because "it kept going up" starts panic-selling, which in turn drives further panic selling. Then, on top of that, you get the folks who got in relatively early deciding that taking profits is a pretty good idea. As the stock comes down, more folks decide that it's time to take profits (or to cut losses) and you eventually have a stock that violently crashes and burns, turning many paper fortunes into modest gains or even losses.
So, what killed UniPixel? It's simple. The company itself is well known for delays and promises that don't pan out, so the minute that it looked as though Uniboss may not have the huge rollout that was expected, the product experienced delays, and other doubts began to surface (a good overview is found here), the shares predictably cratered as reality did not match expectations.
The same will likely happen to Tesla. Management has claimed that it could potentially ship 40,000 cars/year in the coming fiscal year. This means that the stock is building this expectation in. If the company even so much as misses this estimate slightly or - more likely - someone is able to show, with pretty reasonable evidence, that the company isn't on track to hit those numbers (or if gross margins turn out to be worse than expected, for example) then the stock will crater. If Tesla hits those numbers, the situation is still thorny because with a 40k car expectation for the next year, the year after that will have to yet again impress to justify this nosebleed valuation. At some point the game of musical chairs ends, but the question is how long does it go on?
Be careful in getting close to these bubble stocks. They can be immensely lucrative if you can trade them with discipline, but they can be disastrous if you are a wide-eyed believer of the thesis and end up maxing your margin credit card to allocate an unwieldy portion of your net worth to the shares. This stock will eventually crash, and the "long term" buy and holder types will end up in a similar position as those who bought Broadcom (BRCM) at $150+ back during the NASDAQ bubble - with losses that will likely not be recovered during your lifetime.