One of the most frustrating enigmas to encounter among equities is a company whose investors have zero rationality. To my dismay, one of these companies is Tesla Motors (TSLA). Tesla has a product and leader that could do great things together. Indeed, both Elon Musk (Tesla's CEO) and his electric cars have made great strides in technological advancement and energy efficiency. However, there seems to be great wall of irrationality that makes investment in the company questionable.
Mom and pop investors who think their uneducated hunch about the future of electric cars is immune to the difficulty of turning a great idea into money, have hurled cash at their brokers and financial advisors toward the purchase of Tesla stock. Amateur investors are so sensitized by the fairytales of Steve Jobs and Mark Zuckerberg that the slightest whiff of fresh magic dust from Tesla has captured their attention like a kitten chasing a laser pointer.
Revenue (Magic Dust)
The most obvious driver of price for Tesla is revenue. Clearly, investors are fixated on the shear volume of dollars that the company can haul in, with zero regard for how much of that is left when all the bills are paid. This is not uncommon for a consumer company, yet the extreme level of revenue fixation is alarming. Comparing daily closes to the most recent quarterly revenue figure at the time of each close yields the following chart...
(click to enlarge)Regression of the two data sets yields an R Squared value of 0.8254. In other words, the price of Tesla stock on any given day was 82.54% explained by the most recent quarter's revenue. Keep in mind that this is considering total revenue, not revenue per share, which brings us to the next head-scratcher.
Tesla investors have been so irrational that if we make the same comparison, but use revenue per share instead of total revenue, we are left with an R Squared value of 0.8081 and less explanatory power than before. Investors are seemingly unaware or simply do not care that there has been a nearly 25% increase in outstanding shares over the past 3 years.
I will usually be the first to caution that correlation does not imply causality, but an R Squared of 0.8254 is difficult to dispute. Investors are dangerously addicted to the idea that revenue is everything for Tesla.
Without even scratching the surface, an investor should know that any consumer company is going to face seasonal challenges. Quarterly revenue is compared YOY (year over year) rather than back to back because in many cases, seasonal demand would make a back to back comparison useless. Even so, Tesla investors have not seen fit to bear that in mind amidst hurling cash at the company right after earnings announcements. The close correlation between quarterly revenue and price means that one might actually make a strategy out of shorting the company before the slowest season, when bewildered investors will surely sell off, and investing before the highest season. If and when the company reaches maturity, these seasonal differences will be much more pronounced.
The Beta Fallacy
The company's low monthly beta of 0.76 appears to be a crutch for investors, but this number is quite useless. In addition to the fact that the company has only been publicly traded for about 3 years, regression calculation for the company's beta exhibits an R Squared value of 0.0210. With only about 2.10% of returns explained by the S&P500 index (the broad market), investors are largely at the mercy of other irrational investors.
Separating traditional beta into upside and downside betas creates still more cause for concern (for a little more information on dual-beta for those unfamiliar, look here). In month's when the S&P 500 saw decline, Tesla declined by 2.16 times as much on average with an R Squared value of 0.293 (almost 15 times stronger explanatory power than traditional beta).
If you think that is the end of the irrationality, take a look at the company's upside beta. With an R Squared of 0.0004, the company's upside is probably more correlated with next week's lottery numbers than the overall market.
Keeping these metrics in mind, an investor's upside is a shot in the dark, while downside is extremely unattractive and nearly 30% explained by the movement in the broad market. For the other 70%, your guess is as good as mine.
How To Tackle Tesla
If you are a gambler, you can religiously follow the predictions and quotas about the company's predicted car sales, which account for an overwhelming majority of the revenue, and invest with a high level of confidence that your investment will appreciate on pace with revenue. But beware: this revenue "magic dust" will only stick around as long as the irrational investors do. At some point, they will get bored, especially if the company's eccentric CEO gets caught up in one of the other two cutting edge companies he is steering.
A much safer play would be to invest in Tesla's suppliers or prospective suppliers. This represents a safe way to secure some exposure to Tesla without submitting blindly to the will of its irrational investors.