For anyone following Tesla (TSLA), one would be hard pressed to think back to when the stock has not been making new highs lately…until yesterday, when one of their cars literally went up in flames when its battery caught fire. No one was hurt, but now this fast-accelerating stock has hit a speed bump, dropping about about 6.5% from its highs.
Up 445% year-to-date until this news, it had been nearly impossible to go wrong with TSLA unless you had the temerity to try to short it. But will the next 12 months be as rewarding? Can the company possibly blow out expectations over the next year the way they have over the last year?
Justifying Sky-High Valuations?
A big part of the reason TSLA’s valuations are somewhere north of ridiculous (15.47X price/sales, 34.22 price/ book — even after the car fire) is because the company is investing aggressively into R&D and ramping up production capacity. If a company of TSLA’s size has BMW (BMW), General Motors (GM), and Toyota (TM) in its sights, it will have to reinvest the large majority of its profits into increasing its scale. Reporting fantastic net margins and solid EPS growth each quarter in order to satisfy traditional Wall Street valuation models will have to wait.
For the first half of 2013, the Model S accounted for 12% of the luxury sports car market in the U.S. – a remarkable achievement for the company’s second mass produced model. Additionally, TSLA has a significant lead on its infrastructure build-out of charging stations. Its Superchargers are incredibly fast, averaging 16x the charging speeds of most public charging stations. The company plans to have Supercharging stations within 98% of the population by 2015. This infrastructure lead could prove invaluable for future TSLA models when competing with standard gas-powered competitors.
However, no conceivable validation for TSLA’s share price can be argued without invoking the prospects of the company’s Gen III EV sedan, the “affordable Tesla” slated for release within three to four years. Although the Model X, a gull-wing crossover SUV, is coming to market in 2014, the company’s real expansion into mass market primetime is expected with the launch of the Gen III, a car that CEO Elon Musk has said will compete head-on with the BMW 3 Series in the $30k to $40k range. But little is known about the Gen III and with a release date set for 2016 at the earliest, it is not likely that even glowing sales projections would hold up the current stock price if sentiment started to turn.
Reality, Kicking In
Although the company may be managing its future growth wisely, it doesn’t have any control over the stock price and how lavish the market becomes with its buying enthusiasm. Any stock can over-accelerate its prospects, no matter how golden they may be. And a 560% return over the last 12 months is simply too much for the best execution to catch up with for the near-term horizon.
As the Christian Science Monitor observed, TSLA commands a market cap that is nearly 47% that of GM. They state, “GM has built over 450 million cars in its 105 years while Tesla has made about 25,000 cars over 10 years.” (Perhaps it says something when even the Christian Science Monitor is taking note of TSLA.)
On September 23, Bank of America Merrill Lynch sounded a surprisingly direct warning on TSLA, calling the shares “vastly overvalued” and reiterating a price target of $45, a -75% correction from its current price. They derive this target using an EV/EBITDA multiple drawn from the average of 35 growth-oriented tech companies. While this approach may not be very applicable for TSLA’s stage of growth, it nevertheless highlights some of the institutional skepticism building over the stock.
But a more direct measure of this skepticism is in the decreasing levels of institutional ownership. As BofA Merrill Lynch also notes, institutional ownership of TSLA has actually been declining since May of this year, from about 87% of shares then to approximately 66% today. In fact, institutional ownership fell precipitously as the stock crossed the $120 mark. Granted, that is a lot of upside that these sellers have given up since that time. Secondly, it still leaves 66% of shares owned institutionally. But it appears that TSLA’s remarkable outperformance this year has been enough for many funds to take their leave and book profits.
Fundamentals are One Story, Technicals Another
Does TSLA’s rapid rise mean tougher times lie ahead for shareholders? It is notoriously difficult to talk price targets, or to say how high is too high when emotion and speculation have gripped a stock. Concerns of TSLA being in a bubble surfaced at $80, at $120, at $150, and every new high has been met with as much exasperation as excitement.
But one thing is certain: emotion and speculation cut both ways. Once the sentiment shifts, it can shift fast and hard, as we’re starting to see today. This will make it difficult for those committed to TSLA’s business model and long term prospects.
From a trading viewpoint, however, especially for trend-following, it makes more sense to look at the long-term view. TSLA has been acting beautifully, and virtually any set of trend-following rules would have kept you in the stock for the entire run since early April when it broke out of a range into the low $40s. While it is still fundamentally overvalued, TSLA has not yet shown signs of technical exhaustion or formed any reversal patterns. Of course, it is easier to stay with a TSLA trade if you happen to already be in it. The real question is whether to open a new trade at these price levels.
Technically, TSLA’s trend could push into the $200-$220+ level. However, the 30-day moving average has been a good watermark level for low tides in the stock, the sole dip below it coming in mid-July when Goldman Sachs (GS) published some concerns on the company’s margins in a research report. This drop was quickly erased and it has stayed elevated above the 30-day MA for the last two and a half months, though with today’s panic sells it is starting to approach that level again.
If you are looking to enter a trade here, keep it simple. Enter near the 30-day MA, keep stops at or near the 50-day MA, and use new highs as confirmation of trend continuation. The trend here is TSLA’s best asset. Any failure to surpass previous highs should be seen with heavy caution. Don’t be caught on the wrong side of a trade when sentiment shifts.
Option traders should consider the TSLA December 2013 at-the-money calls on a bounce off support.
InvestorPlace advisors John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.
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