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Paulo Santos, Think Finance (372 clicks)
Long/short equity, arbitrage, event-driven, research analyst
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Stocks can be seen as a couple of different things. They are slices of company equity. They are also products in their own right, bought, sold, distributed, promoted, discounted and liquidated. We see this every day in the way people justify their actions because of what they expect to happen to a company's profits. How they see potential in a new product. How a threat emerges that clouds the future.

But stocks are also like streams, rivers if you will. Where shareholders flow from one to the other, selling a stock here to buy a stock there. Trying to maximize what they make, or avoid losses. And some streams seem to naturally flow into others.

Some stocks, like Amazon.com (AMZN), were clearly favored by other stocks attaining large share prices. Apple (AAPL) traded at $700, so Amazon.com could trade higher. Priceline (PCLN) traded at $800, so Amazon.com could trade higher. The connection is there for those who ignore what market capitalizations or earnings are. Or how they relate to one another.

This force can also be seen in lower priced stocks, where if something trades at $0.90 after trading at $90, a lot of its shareholders won't sell. They'll hold. After all, how could it become much worse at this point? Again, ignoring market capitalization and earnings, both present and prospective. Until the day there's a reverse split, of course, and the share goes from $0.90 to $45. Then, even though the value is the same, the share suddenly looks like it could fall a whole lot more. And it does, because those that wouldn't sell it before at $0.90, now sell it as quickly as they can at $45.

So a lot of people stream from one stock to the next purely based on the share price and how they see it as reflecting value, even though it really doesn't relate all that much to academic notions of value embodied in market capitalization and valuation techniques relying on earnings and their derivatives (cash flow, EBITDA, etc).

All this to say that the weirdest things lead people to buy and sell stocks, going from one to the other. And to introduce what I believe is the latest stream that ought to have some short investors worried. Enter SolarCity Corporation (SCTY). SolarCity designs and installs solar energy systems. There's some growth there, but it's a wildly competitive field so margins are not decent and probably will never be. But SolarCity has another important thing going for it: Elon Musk.

Elon Musk, obviously, is better known for Tesla (TSLA). And both Tesla and SolarCity can easily capture the imagination of shareholders. So SolarCity is also a gigantic valuation bubble, much like Tesla if not worse (given how unlikely the business is to be attractive over time).

But SolarCity shorts -- and there are a lot of them, short interest is 8.7% of shares outstanding and double that regarding the float - are getting slaughtered, no matter what we think about SolarCity's valuation or prospects. So why is this happening? Put yourself in the mind of someone who recently made a lot of money trading Tesla.

"Oh boy, there was a time when Tesla was at $53 too"

See how they'll stream into SolarCity from Tesla? There is nearly nothing that a short can do regarding this logic. This simply has to go on until it stops, like any other bubble. Valuation, earnings, they're not called for here, for the only earnings these people concern themselves with are those showing in their portfolios. Obviously in the longer term all of these chariots turn into bumpkins. But as Lord Keynes has said, "Markets can remain irrational a lot longer than you and I can remain solvent."

Conclusion

Even though SolarCity is a bubble and should prove to be so in the future, at $4.2 billion the market capitalization is too small to fight it or wait it out while short, given the irrationality that will be pushing it up. If Tesla ever collapses, SolarCity will be much more vulnerable as a stock, even though the two stocks ought to be unrelated.

Source: SolarCity: Stocks Can Go Up For The Weirdest Reasons