Amazon Vs. Tesla

Summary

• Over the weekend, I ran a simple test of options market sentiment on Amazon and Tesla: Amazon passed and Tesla failed.
• Coincidentally, the Financial Times contrasted both companies in its lead editorial over the weekend.
• I describe how the results of options test are consistent with the analysis in the FT's editorial.

Amazon CEO Jeff Bezos (Credit: Drew Angerer/Getty)

Amazon Versus Tesla

On Saturday, I shared the results of a simple test of options market sentiment on Amazon (NASDAQ:AMZN) and Tesla (NASDAQ:TSLA) on Twitter: whether each could be hedged against a single-digit decline over the next several months using optimal, or least expensive, put options. Amazon passed and Tesla didn't. Then, I read the Financial Times, as I usually do on weekends, and saw that their lead editorial - "Musk, Bezos and the art of selling jam tomorrow (paywalled here) - also contrasted Amazon and Tesla. The connection between the two comparisons is instructive, as I elaborate below. Let's start with the FT's comparison.

The Art Of Selling Jam Tomorrow

The gist of the FT's editorial, which opens with a reprise of one of Benjamin Graham's most famous quotes, is that growth companies rely on investors' sights being set on the future, but at some point the future comes around and the money has to be there:

In the short run, the investor Ben Graham said, the stock market is a voting machine; in the long run it is a weighing machine. And what the market weighs in the long run is money. It is true that share prices are forward-facing, reflecting anticipated future cash flows. For most companies, though, if the future consistently fails to arrive, the game is up.

This will be on the minds of investors in electric-car company Tesla, and perhaps that of its founder and chief executive Elon Musk.

If you're tempted to type, "Actually, Martin Eberhard and Marc Tarpenning founded Tesla" at this point, recall that Musk is now legally considered a co-founder along with them. Back to the FT, where the editors address Musk's infamous characterization of an analyst's question as "boring bonehead":

For investors, questions about cash flows are never boneheaded. When a company is burning over $1 billion a quarter, as Tesla is, they are essential. [...] That said, there is a charitable way to interpret him - as meaning the following: "If you are worried about financial results in the short term, Tesla is the wrong company for you to be investing in."

That is the message that the leader of every growing company most wants to send, and rightly. An investor base that accepts it - that is willing to accept jam tomorrow for years or even decades - is an incredibly potent competitive advantage. Consider the case of Amazon. Right from the start, its boss Jeff Bezos made clear that effectively all incoming cash would be invested in the company. Today, nearly a quarter of a century after its founding, the company's operating profit margin is about 2%.

The FT then speculates about what Walmart (WMT) could do if it were able to run on such small margins, before noting that it can't because its investors expect dividends. Then, it gets to the key contrast between Amazon and Tesla:

Even in its early days, Amazon, unlike Tesla, never burnt a lot of cash or took repeated trips to the markets for more cash. It was always able - just barely - to finance itself out of the proceeds of its business. The difference may be down to the different capital demands of the retail and auto industries. But there was another difference, too: the metronomic steadiness of Amazon's growth, and the smoothness with which its business could be seen to expand. As slim as profits may have been, investors always knew the strategy was delivering - a sharp contrast with Tesla's history of production problems and missed forecasts.

The FT wraps up on a hopeful note for Tesla longs:

Tesla is unlikely to be a profitable business any time soon. If it can start to deliver its product with Amazonian steadiness, no one is likely to care.

The optimal put test I ran on Amazon and Tesla is concerned with the next several months, though, and based on it, options market participants don't seem to expect Amazonian steadiness from Tesla within that time frame.

Amazon, Tesla, And The Optimal Put Test

As part of its daily processing that generates the top names I share with Bulletproof Investing subscribers each week, Portfolio Armor applies the optimal put test to names that have passed its two screens to avoid bad investments. Tesla failed the first of those two screens on Friday, because the mean of its most recent 6-month return (its short-term return) and the mean of its long-term return (the average 6-month return of its long term proxy, Toyota (TM), over the past 10 years) was negative, as you can see in the screen capture from my site's admin panel below.

It would have passed the second screen, which is a gauge of options market sentiment, an attempt to collar it against a >9% decline. For example, if the mean of Tesla's short- and long-term returns had been 18%, the site would have been able to find an optimal collar using a cap of 18% and a decline threshold of 9%, as you can see in the screen capture below.

But Tesla would have failed the optimal put test, which is another, tougher gauge of options market sentiment (only about 20% of the securities that pass both of Portfolio Armor's initial two screens also pass the optimal put test). As you can see below, in a screen capture from my tweet on Saturday, there were no optimal puts available to hedge Tesla against a >9% drop on Friday.

Without selling calls to offset the cost of the puts, the cost of protecting Tesla against a greater-than-9% decline over the next several months was higher than 9%.

Amazon, in contrast, passed both of Portfolio Armor's initial two screens...

... as well as passing the optimal put test.

Since it was possible to find optimal puts to hedge Amazon against a >9% decline, the site boosted its potential return upward by 37%, as you can see in the "w/AHP" (also hedgeable with puts) column below in this close-up of the earlier screen shot from the admin panel. The reason for that 37% boost is that, in our research, securities that could be hedged this way generated unhedged returns 37% higher, on average, than those that could not.

Amazon Is A Top Name

Thanks in part to the boost from passing the optimal put test, Amazon was one of Portfolio Armor's top ten names on Friday. The site's top ten names tend to outperform the SPDR S&P 500 Trust ETF (SPY) over the next 6 months, as you can see in the most recent Bulletproof Investing Performance Update.

Wrapping Up: Options Sentiment Reflects Reality

When you consider the contrasts between Amazon and Tesla, as elucidated in the FT editorial, it makes sense that it's possible to cost-effectively hedge Amazon against a >9% decline over the next several months and not Tesla. Tesla is higher-risk, particularly given the possibility it will need another cash infusion. Tesla is also higher-risk in a way not covered by the FT editorial: it has legitimate competitors in high-end auto manufacturers coming out with their own electric cars. Amazon, in contrast, is the dominant company in online retail.

The optimal put test is something you can do with the free version of the Portfolio Armor iPhone app, as I mentioned in the tweet below.

Try the optimal put test on another pair of stocks and see if the results are consistent with your qualitative assessment. Feel free to share your results in the comments.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.