Today a walk through the financial section of any local library or typing "investment strategies" in the Amazon search bar will reveal that there are hundreds of different books on every possible approach to making investments in the stock market. Whether a person prefers a more technical viewpoint or believes fundamentals are what matter most, there is more than a lifetimes worth of reading available to the customer. Yet there are two things that the vast majority of books will have in common. The first unfortunately, is that not a single published author has developed a method for actually predicting the future. The second is that countless books provide some sort of investment checklist. This list may consist of stock market do's and don'ts, several characteristics the writer believes to be qualities of winning stocks or the entire book may be an expanded description of bullish and bearish features but never actually provide the reader with flat out bullet points. In any case, material on investment approaches given to the reader can be boiled down to a list. Having read many such books and through personal observations, there are now several "checklists" of my own. Anyone who actively manages their finances would agree that list like mine are created as much out of necessity as they are practicality; i.e. they really work. Of course, each list can be edited in order to better fit specific situations. For example one list might be for choosing good pharmaceutical companies, another for selecting value stocks, while others for use in bull or bear markets. The review that follows is one with features for selecting good growth stocks and is of the list that was used in making the decision to buy Tesla Motors (NASDAQ:TSLA) on Friday, June 21st.
· The company is a leader in its field
· Political or social backing
· An increase in quarterly EPS and an annual earnings increase
· Innovative products or management with a stake in the company
· Sponsorship from institutional investors
· Display of strength on weak market days
A leader in its field: What is Tesla Motors if not a leader in its field? This has been a good year for automotive stocks; Ford (NYSE:F) is up 32% YTD and GM (NYSE:GM) up 29% YDT. However Tesla shareholders have had more than a good year, with shares currently up 433% year to date, it would be safe to say Tesla is having an astonishing year. Price performance aside, being the leading stock in any field takes more than just what can be seen on a graph.
We all know Tesla Motors is not the first company to take a shot at manufacturing an electric car, though we do know it's the first to actually hit the target. The political landscape, not to mention actual demand for EV's prompted companies like General Motors to produce hybrid cars such as the Volt or Volkswagen to build hybrid Jettas. The list of Hybrid cars goes on and on, but the problem is when it comes time to make the decision to buy a car the pros and cons work out as follows: Pros: it's a really nice Car X that's completely normal to drive, happens to get about 50 mpg and is a Hybrid. Cons: hefty price tag.
There lies the first and foremost issue with marketing new technology to the middle class. It's just too expensive and attempts to make EV's more appealing by turning them into hybrids only worsen the problem. For example the 2014 Volt starts at $34,000. Where is the room for profit? The answer is there isn't any. This price tag is only made possible through extensive government funding of the Volt. (Government funding is an issue because it does not provide lasting profitability to a company, as the worry was with Tesla which received $68 million in zero emission vehicle credits in q1 of 2013) But that's not all; there is another problem with any hybrid on the market. By its very nature a hybrid is a compromise. In short, because of the fact that their half and half, hybrids are neither good gas powered vehicles or high performance electric cars. This means that in reality, no one would really chose a hybrid car if they were given the choice of an all-electric vehicle of the same price and functionality. Here we see Tesla's niche. Price aside, Elon Musk was able to solve these problems by giving the customer what they really want, an all-electric vehicle with a long range and high performance. The Model S just so happens to be a luxury car with a luxury price tag because the EV tech inside the car is expensive. The niche will only grow as price is reduced to a point affordable for the middle class. It is normal for any new technology to be very expensive and as a result most groundbreaking technology begins as toys for the rich. Musk clearly knows this for his first production model car the Roadster is somehow even more expensive than the Model S. It is the understanding that the first target market for any new and expensive technology must be the wealthy that has lead Tesla Motors to profitability and made the company a leader in the production of electric cars and arguably luxury cars as well.
Political or social backing: It is not an absolute necessity that growth stocks have social movements working in its favor, but as we see with Tesla, it never hurts. It is no secret that a certain political party loves anything we have come to label as "green". As a result there is a large group of people who see the electric car as the future, and those particular groups of people are probably right, given that the technology can be made competitive with existing gas powered models. All that aside, there is significant political backing behind companies like Tesla. When the federal government is offering a $7,500 tax credit for purchasing any Tesla car and the state of California is offering a $2,500 rebate on the purchase of all EVs it can do wonders for a company.
In addition to the incentives listed above, there are other reasons it's good to have a political party on your side. Not only are there monetary incentives working in Tesla's favor, but social incentives as well. There is a whole group of people out there who believe that by reducing their carbon emissions they are doing a good deed. Now with the help of Elon Musk, many people are carrying out their philosophy by driving a Model S and looking awesome while doing so. In a word, not only does Tesla Motors have American politics working in its favor, but many of its customers can feel a sense of pride when driving a Model S or Roadster.
An increase in quarterly EPS and an annual earnings increase: Explosive earnings have accompanied big stock moves throughout the stock markets great history in America. It's not a new phenomenon, there is a direct relationship between big earnings and big price moves. As a result, increase in quarterly and annual earnings are a must have when considering any growth stock.
As anyone who has been invested in Tesla should know, all the hype around the stock started when on May 8th of this year the company posted its first ever profitable quarter. The company posted an EPS of $0.10 on a GAAP basis, using 114.7 million weighted shares outstanding. (The quarterly shareholder letters can be viewed here and here, Q1 and Q2 respectively) It was this and this alone that brought much needed interest to Tesla Motors, which just goes to show how important turning a profit really is. Although the surprise profits of $15 million or $0.12 per share of non-GAAP net income experienced in Q2 of this year were not available to me at the time I made my initial investment, it was reasonable to say Tesla was not slowing down based off of demand for the car. It is not very often we see the birth of a new automotive manufacturer, there are of course significant barriers to entry for such a business. Today demand for the Model S is even greater then a few months ago and shows no signs of topping out. As it stands Musk can keep on selling just about every car he is able to make, and shareholders can keep counting on future profits.
Innovative products/ management with a stake in the company: Investing in the status quo might seem to be a safe play, but the truth is it takes something new to seriously advance the price of a stock. It can an important new product or service that sells rapidly and causes earnings acceleration. New industry conditions - such as supply shortages, price increases or the introduction of a revolutionary technology. Or it can be a change of management that brings new life and new ideas to a company. In all cases, whatever they may be, it is vital to understand that events such as those above can really make a stock move and are what good investors look for.
Elon Musk can honestly be described in one word: maverick. The man is a true innovator and is on the verge of becoming a household name, if not already. Musk boasts an impressive rap sheet. From founding PayPal to CEO of SpaceX there is little keeping this man on the ground. Other achievements aside there are at least 5 good reasons that Musk makes the ideal CEO for Tesla Motors or any other company for that matter.
· Musk has a sizeable 28% stake in Tesla, therefore a vested interest in the stock performance
· The company is his baby, the man is not a caretaker and is highly involved in the company
· Elon is very familiar with the cars he makes,(hence the many comparisons to Henry Ford) aside from helping to design them he also holds a B.A. in physics from the University of Pennsylvania and a B.S. in business from the Wharton School of the University of Pennsylvania. It's obvious he is hands on management and knows what he's doing
· Elon is young, innovative, takes risks and moves quickly
· Constantly works to bring relevant, superior new product to the market e.g. the Model X
Everyone knows this list could be longer, Elon Musk has many desirable traits one wishes to see in any CEO. Those above are some of his strongest and most prevalent traits. Perhaps Musk only major weakness could essentially be his greatest strength: his ambition. It has been weeks since Elon unveiled his "Hyperloop" design. The argument that Musk will overextend himself or simply try something too big is not being made here. The man is too smart for that and knows what he can achieve. Only that if he keeps up his current rate of success, and surely he will, one man is only capable of running so many multi-billion dollar companies.
Sponsorship from institutional investors: It takes big demand to push up prices, and by far the biggest source of demand for stocks comes from institutional investors. Whether it is from mutual funds, pension funds, hedge funds, insurance companies, large investment counselors, bank trust or educational institutions these large investors account for the lion's share of each day's market activity.
Not only does institutional sponsorship bring creditability and liquidity to a stock but also puts real support behind the stock moves. That can be a good or bad thing depending on the direction of the move and whether or not it is in your favor. I.e. Institutional investors not only bring heavy buying to the market, but heavy selling as well. As a result the ideal stock will have institutional ownership sitting somewhere between 55-75 percent.
As of today Tesla has an institutional ownership of 58%. Just barely in the sweet spot; however in the past the stock had ownership that was higher than 70%. Keep in mind analyzing institutional ownership is about more than just making sure a certain amount of stock sitting in some fund somewhere. It's also important to take note of who the largest shareholders are. Who has been selling or buying more shares, are there any big names at the top of the shareholder list and have the current investors been successful in the past. Today some of the largest shareholders of Tesla are Capital Research Global investors with 6,020,553 shares, Morgan Stanly with 4,634,189 shares and Vanguard Group Inc with 3,548,682 shares. It is not surprising that all three are very large, very well know investors. Even quickly browsing through this list of institutional investors can prove to be both interesting and revealing.
Display of strength on weak market days:
It was June 19th of this year, on a Wednesday that Ben Bernanke held a press conference expressing optimism in the Fed's outlook for the U.S. economy. Of course, it is common knowledge what happened next, but for this articles sake here is what the DOW looked like by Friday:
The market was affected significantly by the Feds optimism. That Friday was a terrible day in the markets, especially around noon. Of any basket of stocks, more than half were likely to be in the red. Fear, one of the biggest decision making emotions in the stock market was working its magic. Although the stock opened red that day Tesla Motors was displaying investor confidence by that afternoon. It was on that Friday, June 21st, that Tesla received the final check on the buy list the decision was made to pull the trigger on Tesla.
Many readers may point out that it was not just Tesla that made a recovery that Friday. It is clearly visible on the graph above. That may be the case, but if memory serves Tesla made it in the green that day well before the DOW jumped back. It broke past 100 a share that day on high volume before the close in light of the recent recall of 1,228 of its 2013 Model S cars due to a defect in the mounting bracket of the rear seat. Musk turned out to have handled the recall so gracefully that it was actually a plus for the company. That day was a classic example of a strong stock on a weak day. Being the last item on the checklist at the time, I jumped on the stock just as it broke 100 a share.
Since June Tesla has check off more boxes on the list of things making it a good stock and resulting in additions to my original position, once on the July 16th after a Goldman Sachs analyst published a bearish report and a second time after the release of the Q2 report in August. The admission must be made that being the lover of growth stocks I am, I was secretly and unreasonably hopping to see 200 dollars a share at the time of my first purchase. Only now do I feel comfortable actually admitting that as my hope. Although never in my wildest dream did I hope to come so close so soon. With recent highs of over $185 a share it seems that 200 could actually be a possibility for Tesla Motors, and why not? Every passing day seems to add to the long list of news announcements making aware the progress of Elon and Tesla Motors. Of course listening to any bear with a healthy fear of heights will only serve as a reminder that a 22 billion dollar market cap is too massive for the company. But then again so were the 15 billion and 10 billion dollar market caps. There is no denying the possibility of a price drop, but if Elon Musk continues to impress, Tesla Motors will keep making new highs one dollar at a time.
Disclosure: I am long TSLA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.