Time To Short Tesla: Bubble Burst Next?

Jul. 24, 2020 9:33 AM ETTesla, Inc. (TSLA)AMZN400 Comments54 Likes
Paul Franke profile picture
Paul Franke
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Summary

  • Tesla bears have almost universally capitulated, covering a large short position and propelling the stock price 500%+ higher over 12 months.
  • Wall Street analysts are turning bullish right at a potential price peak.
  • The stock is one of the most overvalued on Wall Street vs. trailing fundamental metrics, selling for about the same market value as the rest of the global auto industry.
  • Technical momentum has weakened considerably since February.
  • Conclusion: Now may be a great time to sell or short the stock.

Tesla (NASDAQ:TSLA) has been a favorite short target for years by professional traders, in a train wreck fashion for those standing in CEO Elon Musk's way. Stretched valuations, a lack of profitability, and weak cash flows have been the fundamental reasons to bet against the leading electric vehicle (EV) manufacturer on the planet. The meteoric 500%+ rise in its stock price the last 12 months has been the best example of a painful short squeeze for bearish investors since the end of the Technology Boom in 2000.

Steadily rising sales and auto deliveries, financed with ever greater amounts of debt, have put Tesla cars in millions of U.S. driveways the last decade. The question remains: can the company sustain itself without new debt issuance in a severe economic downturn? Short sellers have answered the question with an emphatic NO and waded into money-losing, borrowed short positions over the years. And, yesterday's Q2 earnings release did not provide any earth-shattering positive news on the cash flow front.

Source: Company Website

For the record, I have never considered shorting Tesla until today. July's $300+ billion valuation is completely and totally overshooting every optimistic estimate of future growth at the same time as short sellers are throwing in the towel. In terms of timing, selling the Tech Boom peak in the year 2000 was a brilliant decision for experienced traders willing to take on plenty of implied risk through contrarian analysis. Mark Cuban, who sold Broadcast.com to Yahoo! in April 1999 near the bubble peak, has been warning new investors about the current market setup resembling the end of the dot-com years of the late 1990s. In an interview last week, Mr. Cuban said:

I had my 18-year-old niece asking me what stocks she should invest in because her friends are making 30% per day and other people just randomly asking me that never look at stocks at all what stocks they should invest in …

Everybody is a genius in a bull market …

Everybody is making money right now because you've got the Fed put and that brings people in who otherwise wouldn't participate.

Carson Block, head of famed short selling firm Muddy Waters, last week warned against shorting Tesla. His views of the underlying reasons to short the company have not changed. He is not a fan of the balance sheet or the company's long-term sustainability with weak cash flows. However, he is scared to death of the monster short squeeze rise of 2019-20.

Short interest and positioning today are the lowest they have been since Tesla started publicly trading. The number of days to cover has fallen to just 1.2x vs. 6x in the middle of 2019 or 30x in early 2013. Below is a decade-long chart highlighting the present sub-10% short position vs. total shares outstanding. Short sellers have almost completely capitulated right at the top?

Wall Street analysts are also giving up on Tesla's bearish story near the top. After the announcement of a solid Q2 beat on revenues and adjusted earnings, on top of the excitement of picking Austin, Texas for a new giga-factory, bearish forecasters have moved into hibernation mode, for the most part. Wall Street analysts across the board are raising guidance and ratings from Sell to Neutral, or Neutral to Buy this week. Who can stand in the way of Tesla's triumph?

Lastly, chatter is all over the financial press regarding the addition of the stock into the S&P 500 index. A final quill in the cap of Mr. Musk, the mainstream recognition of his enterprise as an accepted business success story may, in fact, pinpoint a long-term peak. Talk about being on top of the world, with only one direction to go from here - down!

Don't get me wrong, I will buy an electric vehicle at some point in the next 5-10 years. My gripe is not with Tesla's product. The bearish argument is a function of Tesla's valuation vs. reality. Today's market capitalization is now almost equivalent to the entire automobile manufacturing industry worldwide competing against the company. Do you really think Tesla's future is worth about the same as Ford (F), General Motors (GM), Honda (HMC), Toyota (TM), Nissan (OTCPK:NSANY), Hyundai (OTCPK:HYMLF), Fiat Chrysler (FCAU), Volkswagen (OTCPK:VWAGY), Daimler (DDAIF), BMW (OTCPK:BMWYY) combined? The total worth of all competing public and private car makers, including those in India and China, is in the neighborhood of $500 billion.

Tesla is selling about 400,000 vehicles a year on a trailing basis at little profit vs. an industry number of 80 million globally at a higher profit margin. Tesla's market share is 0.5% of all cars produced worldwide, but its worth is nearly the value of the other 99.5% of automakers. At what point is the long-term valuation too high? If not now, when?

The time to short a tech's parabolic move is when short sellers are in retreat, plenty of good fundamental news is reported, and it's getting harder to envision where new investors will come from to prop up the price at even higher levels. Mispriced securities are ones where the real-world risk of buying or selling has no relation to conventional wisdom's implied risk condition. Right now, everyone believes Tesla is a raging buy when the risks to that trade are completely skewed to the downside in the real world. That perfectly defines the opportunity of a Tesla short at $1,600+ a share on July 23, 2020.

Crazy Valuation

Tesla's valuation is like no other auto company in July 2020. Below is a chart of the 10.8x price to trailing sales multiple on a 3-year graph. Notice the Tesla sales valuation is between 150x and 600x any other major competitor. Plus, this traditional valuation metric is TRIPLE its latest 36-month historical average.

In addition, the company is still struggling to generate any type of real-world accounting cash flow. It has only showed up in small amounts during 2019-20. Below is a 3-year graph of price to sales, cash flow, and free cash flow in the stratosphere. I cannot graph earnings because income has not yet appeared for Tesla.

In terms of Wall Street thinking, current analyst estimates are projecting small operating profits to begin for Tesla in 2020, with business expansion leading to EPS of $22 by early 2023. Basically, if all goes well, Tesla buyers at $1,600 are paying a nosebleed 200x this year's profits, 150x next year's income level, and 75x EPS by late 2022. If you think about it, many short-term bond investments are now paying a higher and safer yield on your money vs. the underlying business returns you are purchasing from Tesla. Yes, sales growth is coming as the world moves toward EV use. But inordinate profits are far from guaranteed with Tesla's leadership position, as EV competition is picking up steam in the auto marketplace.

Technical Picture Weakening

The upside momentum in Tesla has actually been fading fast, despite the large price rise the last 3-6 months. When you compare a variety of technical indicators to other technology mega-cap leaders on Wall Street this year, Tesla scores at the bottom for trend health. Amazon (AMZN), Alphabet (GOOG), Apple (AAPL), NVIDIA (NVDA), Netflix (NFLX), Microsoft (MSFT), Facebook (FB), and many more have powerful underlying indicator formations.

Below on the 6-month vs. 12-month chart formations, you can visually see the lagging performance of some of my favorite technical health indicators. The sharp slowdown in underlying support for the stock price is very worrisome since February. You can say Tesla's upside momentum clearly peaked at the U.S. market's all-time highs in February before the coronavirus economic curse showed up.

The Accumulation/Distribution Line (ADL) has barely risen since February. A clear non-confirmation of the uptrend that was in sync with the price rise during late 2019, the ADL measures intraday buying and selling. If a stock closes nearer the high trade of the session's trading range, the line is rising. If selling happens during the day into the close, the trend is lower. You can review on the above charts the flat performance measured between the blue arrow and circle.

The Negative Volume Index (NVI) direction has been rotten for some time. NVI looks only at trading days with lower volume than the previous session. For Tesla, buyers have been absent on slower news, weak volume days, marked with the red arrow. Why is this important for shareholders to contemplate? If professional traders and investors are large net sellers on slow volume days, what happens when Tesla's growth news flattens for a spell or heaven forbid, bad news is reported? The likely answer is there will be an onslaught of sellers and a price collapse. Versus other companies with more realistic valuations, bad news (either from operations, or a weakening global economy, or another stock market dive) will not ruin the stock quote immediately.

Lastly, On Balance Volume (OBV) has been stagnant the last six months. While other big tech names are witnessing net buying vs. selling as a function of volume, Tesla is not. OBV is the most basic measure of money flowing into a security. High volume up days and low volume down days are the preferred setting for strong volume buying trends. In Tesla's case, just as many big volumes up days have been offset by down days. This situation is vastly different than the second-half 2019 OBV reading. You can review the slackening OBV line between the green arrow and circle since February.

Final Thoughts

I am focusing on the timing "process" of when to short a high-flyer in this article. When good news is out, everyone is bullish, and technical weakness is creeping into momentum indications, it might be an opportune moment to consider initiating a short position or selling longs to capture profits. On basic financial metric analysis, Tesla is one of the most overvalued stocks on Wall Street.

My biggest worry for Tesla as an operating business is sharply lower than expected car sales will materialize soon. One of many reasons could crop up in the second half of 2020 to slow growth significantly. (1) Incomes in America may be about to implode. Without a serious stimulus package in the coming weeks from Washington politicians, PPP loan support for small business, unemployment checks at the extended $600 a week rate, and the $1,200 per taxpayer rebates will have ended by August 1st. If no new stimulus is passed, we could be looking at the biggest hit to U.S. incomes and confidence in our lifetimes. We have reached the end of a financial cliff, where a recession turns into a depression, if we are not careful. Car buying has held up well during the first half of 2020 from government handouts about to expire. I am afraid few analysts are factoring in a double-dip recession or worse in their rosy Tesla sales forecasts. (2) The coronavirus doesn't go away until the middle of 2021 or later. Under this scenario, car buying of any sort will dry up quickly in the U.S., especially if combined with a drop in consumer incomes. (3) New events on the ground could appear before or after the November election, as efforts to sway or keep power run amok in America. For example, Tesla's Chinese exposure is quite worrisome in the current political environment. Without doubt, the Chinese manufacturing and car sales market have been critical components of Tesla's success. New export/import tariffs by either the U.S. or China, or retaliatory actions in China to limit Tesla's access in the country are serious risks the next 3-6 months. And, (4) competition in the EV marketplace is ramping up dramatically, which may destroy sales and margin growth at Tesla. A worst-case scenario is the company will soon face hits from all four variable changes into 2021.

Should the "greater fool theory" continue to unfold in favor of wildly bullish investors, limited exposure and buy-stops can get you out of a losing position quickly. The greater fool theory explains the insanity of bull markets at the end of an irrational rush of buying, not based in long-term fundamentals or a level-headed analysis of reality. Essentially, big price gains suck in new investment capital, no matter what the fundamentals of a business can support. The hope is new investors will be even more foolish with their money and be willing to pay yet higher prices in the near future.

Another note when trying to time a technology boom stock is new markets can undercut your short sale analysis. Tesla is aggressively moving into new markets like EV trucks and solar panels. If it can morph owned technologies and expertise into more profitable avenues, a total wipeout in the stock quote may be avoided the next 2-3 years. To me, this is the argument that could derail a 70-90% stock price crash for Tesla.

Here is an example of technology morphing. I have never been a big fan of Amazon (AMZN). Not when Jeff Bezos started the online book seller in the late 1990s; not today when it is one of the largest companies in America by equity market capitalization. Believe it or not, selling in volume at super-low margins has historically been a horrible retail idea, statistically speaking. The number of successes is very small vs. thousands of failed attempts in America.

Amazon's product selling business is still barely profitable 22 years after inception. Almost all of Amazon's value for shareholders is now coming from its technology backbone position for the entire internet and Prime subscription sales for online media products and free shipping. High profit margin cloud revenues (selling scalable computer space to other companies) and a push into home security/music/television initiatives have supported the growing stock quote since the 2009 recession. Luckily for my net worth, I have only shorted Amazon once, taking a minor 5% loss.

Can Tesla rise above $2000 a share in the next month or two before going to $1000? Sure it can. But if you keep a short position to a small percentage of your portfolio, a $2500 quote ($450 market capitalization) would not bankrupt you.

If you decide to sell securities short, keep in mind a borrowed position involves a greater degree of risk than simple long purchases. An investor can lose more than initially invested, so high levels of diversification are recommended. A number of longs and shorts held together in a hedged portfolio design is the best way to lower the risk any single position will ruin your performance. Don't be afraid to limit your losses at 15-20% with a stop-loss order on your short trade.

Please consider this article a first step in your research process, if interested in selling or shorting Tesla. As always, please consult with a registered and experienced investment advisor before making any trade.

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This article was written by

Paul Franke profile picture
16.45K Followers
Nationally ranked stock picker for 30 years. Victory Formation and Bottom Fishing Club quant-sort pioneer.....Paul Franke is a private investor and speculator with 35 years of trading experience. Mr. Franke was Editor and Publisher of the Maverick Investor® newsletter during the 1990s, widely quoted by CNBC®, Barron’s®, the Washington Post® and Investor’s Business Daily®. Paul was consistently ranked among top investment advisors nationally for stock market and commodity macro views by Timer Digest® during the 1990s. Mr. Franke was ranked #1 in the Motley Fool® CAPS stock picking contest during parts of 2008 and 2009, out of 60,000+ portfolios. Mr. Franke was Director of Research at Quantemonics Investing® from 2010-13, running several model portfolios on the Covestor.com mirror platform (including the least volatile, lowest beta, fully-invested equity portfolio on the site). As of August 2022, he was ranked in the Top 5% of bloggers by TipRanks® for stock picking performance on positions held one year. A contrarian stock picking style, along with daily algorithm analysis of fundamental and technical data have been developed into a system for finding stocks, named the “Victory Formation.” Supply/demand imbalances signaled by specific stock price and volume movements are a critical part of this formula for success. Mr. Franke suggests investors use 10% or 20% stop-loss levels on individual choices and a diversified approach of owning at least 50 well-positioned favorites to achieve regular stock market outperformance. The short sale of securities in overvalued, weak momentum stocks as pair trades and hedges is also a part of the Victory Formation long/short portfolio design. "Bottom Fishing Club" articles focus on deep-value candidates or stocks experiencing a major reversal in technical momentum to the upside.
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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in TSLA over 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.

Additional disclosure: I am/we are short QQQ.

This writing is for informational purposes only. All opinions expressed herein are not investment recommendations, and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity and is not a registered investment advisor. The author recommends investors consult a qualified investment advisor before making any trade. This article is not an investment research report, but an opinion written at a point in time. The author's opinions expressed herein address only a small cross-section of data related to an investment in securities mentioned. Any analysis presented is based on incomplete information, and is limited in scope and accuracy. The information and data in this article are obtained from sources believed to be reliable, but their accuracy and completeness are not guaranteed. Any and all opinions, estimates, and conclusions are based on the author's best judgment at the time of publication, and are subject to change without notice. Past performance is no guarantee of future returns.

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