Tesla: Who Got It Right

Summary

• Amid the bearishness on Tesla ahead of its earnings release, social data miners LikeFolio offered a bullish take, noting Tesla's purchase intent was at an all-time high.
• I elaborate, present my site's current take on Tesla, and show ways longs can limit their risk in case the bears are right.
• I close with suggestions for both bulls and bears.
• Members of my private investing community, Bulletproof Investing, receive real-time trade alerts on this idea and many more. Learn more today >>

Image via Evobsession.

Who Got Tesla Right Before Earnings

Ahead of Tesla's (NASDAQ:TSLA) earnings release this week, two prominent Tesla owners announcing they were getting rid of their cars exemplified the seemingly widespread bearishness: hedge fund manager David Einhorn (the subject of my recent article, Einhorn Agonistes) and NYU marketing professor Scott Galloway (at about 7:30 in this Bloomberg TV video). One observer bucking the bearishness was social data mining company LikeFolio, which told TD Ameritrade (AMTD) customers that Tesla's purchase intent on Twitter (TWTR) was at an all-time high.

I'll elaborate on that below, present my site's take on the stock, and close with suggestions for both Tesla longs and shorts from a neutral perspective. First though, for Tesla shareholders who want to limit their risk over the next several months in the event the bears end up being right, here are two ways of doing that.

Safety First: Adding Downside Protection To Tesla

Let's assume, for these examples, that you have 200 shares of Tesla and can tolerate a 20% drawdown, but not one larger than that. Here are two ways to protect against that (the screen captures here are from the Portfolio iPhone app).

Uncapped Upside, Positive Cost

As of Thursday's close, these were the optimal, or least expensive, puts to hedge 200 shares of Tesla against a >20% drop by mid-March.

The cost of this protection wasn't cheap: $8,910, or 12.75% of position value, calculated conservatively, using the ask price of the puts (in practice, you can often buy options at some point between the bid and ask).

Capped Upside, Negative Cost

If you were willing to cap your upside at 18% over the same time frame, you could have used the optimal collar below to get the same level of downside protection.

After an iterative process taking into account the net cost of the collar, the hedging algorithm was able to use a less expensive strike for the put leg, which had a cost of $5,660, or 8.1% of position value. But the income generated from selling the call leg was slightly higher than that: $5,710, or 8.17% of position value (calculated conservatively, using the bid price of the calls).

So your net cost was negative, meaning you would have collected a $50 net credit when opening this hedge, assuming you placed both trades at the worst ends of their respective spreads.

Now we've looked at limiting downside, let's look at how LikeFolio looks for upside in social media data in general, and then look at their take on Tesla ahead of its earnings.

LikeFolio: Using Social Media To Source Stock Ideas

Several years ago, one of the early pioneers in using social media data for investment purposes was London-based Derwent Capital Markets, which launched a hedge fund in 2011 using Twitter data to gauge market sentiment. The idea for the fund came from a research paper by Johan Bollen, Huina Mao, and Xiao-Jun Zeng that claimed to have found a method of using Twitter data to determine the daily direction of Dow Jones Industrial Average with 87.6% accuracy. Derwent's Twitter hedge fund was shut down, shortly after opening, prompting Martin Bryant of The Next Web to comment:

it appears that there simply isn't much market appetite for investments powered by social media sentiment. [...]

It seems that the market simply isn't ready to put its faith in the wisdom of digital crowds just yet.

Bryant may have spoken too soon. Today, both institutional investors as well as retail investors are using social data aggregated by LikeFolio (for example, TD Ameritrade now offers its retail customers social data provided by LikeFolio, as AMTD managing director Nicole Sherrod explained in this Fox Business interview). Unlike earlier approaches such as Derwent Capital's short-lived fund, LikeFolio's approach isn't to gauge market sentiment directly, but to gauge sentiment about brands that roll up to publicly traded stocks.

There's a lot of chatter on social media about individual stocks, but a challenge with generating any useful data from it is the tendency of an investor to "talk his book": Anyone who is long a particular stock is likely to make bullish comments about it, and vice-versa. LikeFolio avoids this challenge by mining comments about brands owned by publicly traded companies, rather than the stocks themselves, as the image above from its website illustrates.

Someone who comments about Yum Brands (YUM) on Twitter may be talking his book, but, for every YUM investor there are many more Taco Bell, KFC, and Pizza Hut customers, and they are sharing their thoughts about those brands on social media constantly (to see an example for yourself, enter "Taco Bell" in the search field on Twitter now, and click the "Latest" tab). LikeFolio used that data a few years ago in a warning, which was confirmed by the company's disappointing earnings release a few months later.

LikeFolio's Take On Tesla

This was the key chart from LikeFolio's presentation on TD Ameritrade's network on July 31st, showing that even as Tesla's stock was slumping ahead of its earnings release purchase intent - social media users talking about buying Tesla's cars - were at an all-time high.

The image above is a screen capture from the video embedded in the tweet below, from TD Ameritrade's Kevin Hincks.

That video segment is only about seven and a half minutes long, so I'd suggest readers take the time to watch it, but I want to highlight one impression from it. LikeFolio co-founder Landon Swan mentions another measure they track, customer happiness, and says Tesla's has always been high, and was holding at a high level. He also notes that people tweet excitedly when they see a Tesla on the road, which doesn't happen much with other car companies.

That brought to mind an observation by Jim Collins and Jerry Porras in their classic book Built To Last: Successful Habits Of Visionary Companies. In that book, Collins and Porras wrote that visionary companies were "cult-like places to work": Workers were enthusiastic believers in the company, to the point where they appeared like cult members to outsiders.

Collins and Porras wrote that in the '90s, well before Tesla was founded, and before Apple (AAPL) had physical stores and iPhones, but it occurred to me that Tesla, like Apple, was a cult-like place to buy. Apple offers more obvious visual evidence of this, with ubiquitous photos of ecstatic customers holding their new iPhones after waiting online for the latest version.

Credit: Wired.

While evidence of Tesla's cult-like customers is more common on social media, where LikeFolio does its data mining.

To be clear: I am emphatically not equating Tesla to Apple in any other way except in the cult-like enthusiasm of their respective customers (even Professor Galloway, in the Bloomberg segment where he mentioned selling his Tesla, raved about the car. His issue was with Elon Musk's recent tweets.).

Portfolio Armor's Current Take On Tesla

As this image from the site's admin panel shows, Tesla currently passes its two initial screens, but has a low single-digit potential return estimate over the next 6 months.

As of Thursday's close, as you can see below, Tesla's potential return net of hedging cost made it #863 on Portfolio Armor's daily ranking of securities.

By way of comparison, Apple had a potential return of nearly 30%,

and was #10 on the site's daily ranking, as I mentioned in a comment on my recent Apple article ("Make Way For MAGA").

I've been sharing the top 10 names from this ranking with Bulletproof Investing subscribers each week since June 8^th of last year, so we have 6-month track records for 35 weekly cohorts as of last week. 28 of them outperformed the SPDR S&P 500 ETF (SPY), and Portfolio Armor's top names averaged returns of 15.62% over the next 6 months, versus 7.71% for SPY.

Wrapping Up: Neutral Thoughts

I don't have a dog in the fight between Tesla bulls and bears, so I'd like to offer a suggestion to each group, from a neutral perspective.

• For the bulls: consider hedging. The first hedge is expensive, but the second one isn't, and if there's a dip in the stock in the next several months, you may be able to buy-to-close the call leg for a lot less than you bought it for, eliminating your upside cap.
• For the bears: consider not fighting the tape. If you end up being right, there will be plenty of downside from here. Why not wait to short when the stock is closer to $200?

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.

I'm friends with LikeFolio co-founder Andy Swan, but I have no business relationship with him or with LikeFolio.