Tesla Inc (NASDAQ:TSLA) is a tempting target for short sellers. Just some of the reasons include: the company continues to lose money; there is the expensive and complicated acquisition of SolarCity; the competition is intense; and there are tremendous challenges with production.
But of course, shorting TSLA stock has been mostly a nightmare. And this has been the case for some of the world’s top investors, such as Kynikos Associates’ Jim Chanos.
According to a report from CNBC, hedge funds have lost over $3.64 billion shorting TSLA stock since the start of 2016. In fact, during the most recent earnings report, the losses came to over $600 million.
Interestingly enough, Tesla CEO Elon Musk has provided warnings to short sellers! Back in April 2016, he went on Twitter Inc (NYSE:TWTR) to say that it was “probably unwise” to make a bearish bet.
OK then, so when looking at Tesla stock, what are some of the lessons when it comes to short selling? Well, let’s take a look at three:
TSLA Stock Lesson No. 1: Technical Issues With Short Selling
Short selling is really for those investors who are experienced and have the time to do the necessary due diligence. The reason is that the risks are significant.
In order to short a stock, you must set up a margin account. This is because you are borrowing stock and then selling it on the open market. What’s more, the brokerage firm wants protection on the trade. In other words, if the stock price goes up, then you will get margin calls, which is a request to put up more money.
The brutal irony is that you may ultimately be spot-on about the bear case of a stock but still lose a bundle since you do not have enough financial resources to maintain the trade.
As the legendary economist John Maynard Keynes once noted: “The market can stay irrational longer than you can stay solvent.”
TSLA Stock Lesson No. 2: Is There a Fatal Flaw in the Company’s Business?
Shorting a stock because it is trading at a nose-bleed multiple is often not the best approach. As seen with companies like Amazon.com, Inc. (NASDAQ:AMZN), traditional approaches to valuation do not always apply. Investors may be more interested in the growth story or the potential for ultimately dominating an important market.
Instead, successful short-sale trades often involve deep fundamental issues that could destroy a company. Here are just some of the examples:
- Fad: This is where the market for a product proves to just be temporary. Think Planet Hollywood, Coleco’s Cabbage Patch dolls and Happiness Express’s Mighty Morphin Power Rangers.
- Disruption: This is when a company’s legacy business cannot effectively transition to consumer needs. A classic example is the impact of Netflix, Inc. (NASDAQ:NFLX) on Blockbuster Video.
- Accounting: Yes, there are some companies that are built on fraud, like Enron and Worldcom.
As for TSLA, there were always risks. Let’s face it, many startup auto operators have failed. But Musk was able to learn from these examples and develop ground-breaking technologies. More importantly, he has plenty of experience in scaling disruptive companies — resulting in standout returns for shareholders.
TSLA Stock Lesson No. 3: Listen To Musk
But isn’t the Model 3 a make-or-break risk for TSLA stock? I agree. The transition will be extremely difficult.
Yet Musk relishes challenges and has made the investments to build a powerful infrastructure. At the same time, he has been very skillful in setting the expectations. He recently noted that the next six months will be “production hell.”
For the most part, he has bought himself some time, in which Wall Street will probably give him a pass. So again, it’s probably a good idea to listen to Musk — and this means a short sale will probably remain a mistake.
Tom Taulli runs the InvestorPlace blog IPO Playbook and operates PathwayTax.com, which provides year-round tax services. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.