Here’s the thing about cult stocks like Tesla (NASDAQ:TSLA) stock. When something bad happens, the bears always overreact. When something good happens, the bulls always overreact.
Tesla reported a mixed third quarter on Wednesday, beating earnings expectations by a wide margin and missing slightly on revenue. Management also said its Shanghai factory is nearly up and running. Tesla surprised me with the profitable quarter, and I’m not the only one.
But before I could even begin putting together a story on how bears may want to reconsider their thesis, TSLA stock rallied 28.7% in two days. Of course, that’s a ridiculous reaction.
The numbers the bulls went berserk over were Tesla’s earnings per share and cash flow numbers. Analysts were expecting a small EPS loss from Tesla. Instead it reported positive EPS of $1.86. Tesla also reported positive cash flow of $371 million.
But remember, Tesla has done both of these things before. EPS is actually down 35.8% from the same quarter a year ago. Free cash flow was down 40% from the second quarter and 58% from a year ago.
Automotive gross margins were 22.8%, down 2.97 percent from a year ago. I swear I’m not making these numbers up.
Overall revenue was down 7.3% from a year ago. Vehicle deliveries were up just 2% compared to the second quarter.
In a nutshell, Tesla’s weakness (profitability) became a strength in Q3. It’s strength (growth) became a weakness.
I said earlier this week that Tesla would likely be reporting bad numbers. “Bad” is a subjective term, but the numbers above speak for themselves. These are the numbers that triggered a 28% gain in Tesla stock.
Is the Market Move Real?
Before I give TSLA stock bulls too hard of a time for overreacting to the quarter, there’s a good chance market dynamics are driving some of the huge move. Prior to earnings, TSLA stock had the second largest short position of any U.S. stock at about $8.4 billion.
There’s a good chance Q3 earnings were good enough to send many of those short sellers running for the hills. As I said this week, I have been a long-time skeptic of the valuation of TSLA stock. But Tesla’s massive short position is one of the biggest reasons I have never shorted the stock myself. Two-day moves like these can easily happen when short covering combines with long buying.
It will probably take a week or two to determine just how much of the huge rally was driven by long buyers and how much of it was driven by short covering. If the stock pulls back significantly, short covering was likely a major contributor.
TSLA Stock Valuation
Once all the bulls and bears stop calling each other names in a few days, investors will need to sit down and actually assess TSLA stock and its valuation. Incredibly, this week’s rally has made Tesla the most valuable U.S. automaker, passing General Motors (NYSE:GM) and pushing it further ahead of Ford (NYSE:F).
Tesla just reported EPS of $1.86 and revenue growth that’s down 7.3%. Ford reported EPS of 36 cents and revenue growth down 2%. In the second quarter, GM reported $1.64 in EPS and revenue growth down 1.9%.
Tesla’s numbers don’t really stand out compared to GM or Ford, but its valuation sure does. Assuming Tesla can maintain $1.86 in EPS for the next three quarters (a big if), it currently trades at a forward earnings multiple of about 43.3. Ford trades at 6.2. GM trades at 5.4.
You don’t have to take my word for it.
“We have to question whether the valuation premium being ascribed to TSLA as a ‘growth’ or ‘technology’ unicorn is truly justified,” Bank of America analyst John Murphy says. “We would point out that [original equipment manufacturers] in our coverage typically trade at about 3x [enterprise multiple] or about 10x [price-to-earnings] through cycle, which in isolation implies a theoretical stock price of $28 on our revised 2020 estimates.”
Bank of America was so impressed by the quarter that it reiterated its “underperform” rating and raised its price target from $225 to $235. The new target is about $90 below its current share price.
I think “underperform” is an appropriate rating for TSLA stock. For the past five years, short sellers have been wrong and bulls have been wrong. TSLA stock is up 37%, underperforming the S&P 500’s 54% gain. Until TSLA puts up numbers that differentiate it from other automakers, I believe that underperformance will continue.
As of this writing, Wayne Duggan did not hold a position in any of the aforementioned securities.