Car manufacturer Tesla Motors (NASDAQ:TSLA) is one of the most discussed stocks on Seeking Alpha. Most articles come from the shorts but there are also long articles. I am short for many reasons.
The way I look at stocks is from a statistical point of view. I see a long or short position as rolling a dice. A stock bet can have a positive or a negative expectation value. So when I consider rolling the stock dice my question is: is it good for a small bet? Below I will give you the reasons why Tesla stock is a bad long bet and even a good short bet, on a statistical basis.
1. Tesla Motors' stock has unfavorable multiples. There are 2 key comparisons: price versus book value and price versus income. To see how this works in practice let's compare Warren Buffett's pick General Motors (NYSE:GM) with Tesla Motors.
See the table below, with data from Yahoo Finance:
Market cap (billion USD)
Revenue (billion USD)
32 (13 after the dilution in May)
You get the idea? They are similar companies in market cap and leverage, and yet General Motors is much cheaper than Tesla Motors, by all metrics! Statistical stock researchers have found that these multiples predict bad stock market returns for Tesla.
2. Tesla is growing fast. Revenue and gross profit doubled compared to 2 years ago. Since revenue and gross profit are often unstable over time Total Assets is a better measure for growth. Total Assets more than tripled compared to 2 years ago. Unfortunately the stocks with the largest growth in Total Assets are performing on average much worse than the stocks with the largest shrinkage in Total Assets. See this paper. I use this when I screen for deep value stocks for my premium research on Seeking Alpha. I avoid deep value stocks showing large growth in Total Assets. These are often dilutive stocks, or stocks with a higher leverage.
Like those deep value stocks with a large growth in Total Assets Tesla Motors is also a dilutive stock. It finances its growth by issuing new shares.
But Tesla Motors also finances its growth by increasing its leverage, or the ratio Total Assets/Total Equity. This ratio went from 3.6 on 31 December 2013 to 9.5 on 31 March 2016. During last conference call Elon Musk said he planned to do this to "de-risk" the company. In May Tesla raised $1.7billion by issuing new shares. Now Tesla's leverage ratio is 4. Tesla is lucky with its high share price. Because the stock trades at such an high P/B only 6% dilution was enough to almost triple the book value of the company.
Unlike General Motors Tesla has a negative cash flow from operations. James O'Shaughnessy reports in his book "What Works on Wall Street" that dilutive stocks with negative cash flows from operations have on average negative stock market returns.
Will Tesla Motors ever grow into positive cash flow from operations? Since the end of 2013 the gross profit has doubled. Unfortunately the costs for "Research" and "Selling, General and Administrative" have more than tripled. As a result the losses increased over the last 2 years. The line "Research" resembles costs for development of new cars. So these could be earned back as soon as Tesla starts selling more cars. However many variable per-car costs are included in the line "Selling, General and Administrative". Therefore it is unlikely that Tesla will grow out of losses anytime soon.
3. Insiders are sellers. Billionaire and CEO, Elon Musk, also owns for billions of Tesla stock. Elon Musk is an extremely successful businessman. He is an example for many investors. He is not selling. Well..., he is only selling to pay the tax on his options. And then he is indirectly selling some more for $94.16 per share cashing $113 million. He does not call it selling, no, he donates the shares to charity. But the donation gets him a tax benefit of $113 million or 94.16 per donated share. See here and here. The bottom line is that $94.16 per share is still a very high price. After the recent dilution it corresponds to a P/B of 5.
Other insiders are also sellers. For example his brother, Tesla director Kimbal Musk, is a seller. Kimbal Musk is also an extremely successful businessman with an estimated net worth of $2.5 billion. So, could Elon Musk be wrong? Could he be wrong about the value of Tesla stock? Stocks with selling insiders do not perform as well as stocks with insider buying, at least on average.
4. Questions have not been answered during the last conference call. Scientists have found that if questions are left unanswered during conference calls future returns are lower. See here for a paper describing the statistics of immediate market reactions on unanswered questions. In my experience unanswered questions can tell a lot about longer term returns as well. To be specific, the company does not want to give numbers on future capex. That indicates the company has large capex requirements that might be difficult to fund.
There might be people thinking profits will come once the new factory opens. They assume much more efficient production in the new factory. There is only one thing we can be sure of. Extra production capacity goes with a need for extra working capital: higher inventory and accounts receivable. And that needs to be financed soon, not next year after the supposed profits have been booked.
5. Tesla Motors' stock is around its 5 year high. This does not take the recent decline into account. When I started to write this article the stock was at $240. The 5 year high was at about $275. The stocks with the most share price growth over the last 5 years have statistically the worst returns going forward. See this paper. This is actually a large statistical effect.
6. Tesla is a very liquid stock. Statistical stock research shows that stocks with lots of trading liquidity perform worse than less liquid stocks. Despite its lower market cap Tesla Motors trades 3 times more liquid than General Motors' stock.
Another good reason to avoid Tesla is the huge amount of buzz around Tesla Motors. That the company is one of the most discussed stocks predicts bad returns. I have seen this many times. High buzz, high prices, no buzz, low prices and a better entry point. This is exploited with the well known "Sell the news". Buzz triggers new buyers and sellers. In other words it creates trading liquidity and liquid stocks have lower returns than illiquid stocks. Now there is lots of buzz around Tesla but there might be a future with less buzz. Buzz can revert to the mean.
7. Stocks are very expensive now. Warren Buffett has seen it all: The overpriced Nifty Fifty stocks, the bear market in 1982, the dot-com bubble, and of course the financial crisis and the preceding overvaluations. What goes up will go down again, although you might have to wait a long time before it actually starts going down. This time is no different. Therefore he invests in General Motors instead of in Tesla Motors.
Stocks have high prices today. For example there are few stocks trading below net current assets in the developed markets. Also general market valuations are at an extremely high Shiller CAPE of 26. This number indicates a bubble as well. I do not expect the general stock market to stay at this level. At the moment shorting the general market is a good bet. Or even better, shorting IPO's with Renaissance IPO ETF (NYSEARCA:IPO) as Chris DeMuth suggested some time ago.
I do think that certain stocks can stay at bubble valuations only because the general stock market is so expensive. Among them is Tesla Motors. Last February the Shiller CAPE was "only" at 24.5. Then Tesla's stock bottomed at $143. I think this dip was related to general market sentiment since Renaissance IPO ETF crashed at the same time as well.
Why investors are still sticking to their shares
With the enormous overvaluation of Tesla's stock it is interesting to summarize why people still stick to their shares. With Tesla Motors there are multiple different reasons. Together all these different reasons make their motivation to own the stock extra strong. Below I will also discuss why these reasons do not make much sense.
1. Many longs are investors betting on the future post-carbon era. These people are not only in the stock for the returns. And these investors are not only small investors. Pension funds also feel the need to invest in climate saving technology. In particular Dutch pension funds are trendsetters. They have invested 37 billion euro in environmental friendly companies. See this Dutch article.
Their implicit assumption is that investing in Tesla Motors is good for the environment. That assumption is wrong. Investors tag a price to capital. By choosing investment A above investment B we make capital for investment A cheaper than for investment B. That means producing with investment A will be cheaper. And that ultimately means people consume more from these products than from products made with investment B. I suppose investing in Tesla Motors is better than investing in over-emitting car manufacturer Volkswagen (OTCPK:VLKAY). However producing Tesla's is still just as polluting as producing other cars, if not more. Charging their batteries is, in practice, very polluting too. For instance during the night batteries will be charged with nuclear or fossil power.
Furthermore most Tesla drivers are heavy car users. They compensate cheaper mileage by driving more. This is how it goes with every luxury good that gets cheaper. For instance mobile phones and computers are cheaper so we use more. Food is relatively cheaper than it used to be. So we eat more. For a better world it would be better if everybody consumes less of everything. Making capital available to others, or investing, does not help reducing consumption.
2. Happy (would be) users of Tesla cars invest in Tesla Motors' stock. People like to invest in what they like to use. Not only in Tesla but also in for example Facebook (NASDAQ:FB), The Coca-Cola Company (NYSE:KO), and so on. The dotcom bubble might not have occurred in 2000 if people had not been so enthusiastic on the new internet. And had the stock market bubble occurred before 1929 if the people had not been so enthusiastic on new inventions like movies and refrigerators?
Investing in what you like can be a great guide for investing but not always. When you connect your feelings about a great product to a stock your unconscious mind often makes a mistake. Your unconscious mind irrationally attaches some of your positive feelings for the product to the company. And many small investors often leave it at that. They do not look that precisely into the balance sheet and the income account. They skip basic questions such as "How, when is Tesla going to earn money?", "How much money is Tesla going to earn?", and "How will that money be divided among the different stakeholders?"
Of course Tesla is a fantastic brand. But, again, how durable is that? Inevitably competition will also come with long-range electrical cars reducing Tesla's margins and increasing the losses. If they cannot make money now, as a monopolist in long-range electrical cars, then it is very unlikely they will make money tomorrow. Besides, it is not unlikely that competing electrical cars will just be better than Tesla cars. Very few companies manage to stay technological leaders for a long time. Recent examples are Blackberry (NASDAQ:BBRY) and Nokia (NYSE:NOK). Car manufacturers are no exception. Already I find driving around in a self-steering Apple (NASDAQ:AAPL) an attractive idea.
A company's likeability usually reverts to the mean. For example we are more aware how bad Coca-Cola is for your health than 20 years ago. We get too heavy if we drink it too much. We are more aware that being obese is bad for our health. And Coca-Cola is not good for our teeth either. Therefore Coca-Cola's likeability is not as good as 20 years ago.
Now Tesla's likeability is at very high levels. That can only get worse. Do you like Elon Musk? Then read this story from his first ex-wife.
3. Investors are betting on growth: more cars sold, more home batteries sold, better margins and so on.
Intuitively it makes sense to invest in growth stocks. Unfortunately statistical stock research, spanning many decades of stock market history, proves the opposite. Investors tend to overpay for growth as numerous scientific papers have shown us. See for instance the paper on increases in Total Assets mentioned above. Even investing in fast growing countries is suboptimal. I read this already years ago in Jeremy Siegel's book "Stocks for the long run".
4. Investors are trusting an authority on running new enterprises. Jim Chanos prefers shorting stocks with famous investors or managers, like Elon Musk. Other investors in these stocks are often blinded with their authority. This is a weakness of almost everybody. Our entire life we are conditioned to follow people with authority: parents, teachers, policemen, bosses, and so on. Likewise many investors in Tesla stock cannot imagine someone like Elon Musk is wrong. They want to follow him instead of unknown managers of the net-nets I am describing every month. So Jim Chanos is exploiting investors' natural tendency to trust authority. See also Robert Cialdini's book Influence.
Elon Musk might be right, but when exactly? That is difficult to predict for a company in the red that will encounter heavy competition. In the mean time diluting will be the best way for Elon Musk to finance capex and increases in working capital.
5. Investors prefer stocks with good price momentum. Investors in Tesla have enjoyed great gains over the last 5 years. They assume that stocks showing a good momentum over the last couple of years will perform likewise going forward. This assumption is wrong as I explained in the first part of this article.
Every investor should have a small short position in Tesla. It's a great bet just based on statistics and elementary investor psychology. If you believe in globally growing car sales you could try a pair trade with General Motors. It could turn out to be a losing bet but the chances are slim. So if you want to stay long, make sure your position is small as well. In that case you won't risk losing too much money.
If you happen to like the growth prospects of the car industry then a less popular company is a better bet. For instance the dirt cheap SORL Auto Parts (NASDAQ:SORL) is much cheaper and therefore will enjoy higher statistical returns. That company is trading at a P/E of 3.4, a P/B of 0.17 and, more importantly, for less than half of its current assets net of all liabilities.
Disclosure: I am/we are short 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.
Additional disclosure: Long SORL.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.