Be Careful; Tesla Stock Has Been Here Before

The owners of Tesla stock should be cautious, since $350 has been a dangerous level for TSLA stock

Everything seems to be going right for Tesla (NASDAQ:TSLA) at the moment. Tesla stock has nearly doubled from its late May lows. TSLA’s third-quarter earnings were solid, with its gross margin improvements suggesting better results ahead. Concerns about its balance sheet have eased, adoption of electric vehicles  is increasing, and Tesla is going to enter new international markets. TSLA CEO Elon Musk even won his recent court case.

Be Careful: Tesla Stock Has Been Here Before
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But that good news might be dangerous for TSLA stock, given its history. This has been one of the most contentious stocks in the market for years. Bulls see skeptics as literally standing in the way of progress. Bears see a questionable business model, an erratic CEO, and a valuation disconnected from the difficult realities of automotive manufacturing.

That divergence even is reflected by Wall Street analysts.  The range of analysts’ price targets on Tesla stock is more than double that of the average of the components of the Dow Jones Industrial Average, as Barron’s noted after Tesla’s Q3 earnings report.

Right now, bulls seem to be winning the debate as Tesla stock continues to rise. But the history of TSLA stock shows that when one side believes it’s finally won the argument, trouble almost always lurks for the other side.

The Problems Facing Tesla Stock

TSLA stock has risen 40% since its Q3 report in late October, including a 17.7% gain in the trading session the day after the results were reported. What’s interesting about the rally is that Tesla’s revenue did not look all that impressive. The company’s total sales actually declined 8% year-over-year. And its Q3 delivery numbers released in early October disappointed investors, causing Tesla stock to fall.

Investors instead have focused on the company’s profitability, which makes some sense. Indeed, I argued ahead of the Q3 release that earnings and margins would be key for TSLA stock.

It’s clear that Tesla has an enormous opportunity. The questions have been whether it can thrive despite competition in electric vehicles from the likes of Volkswagen (OTCMKTS:VWAGY), BMW (OTCMKTS:BMWYY) and Porsche (OTCMKTS:POAHY) — and if Tesla can be consistently profitable while the $35,000 Model 3 generates most of its revenue.

As far as competition goes, EV market growth and Tesla’s first-mover advantage should allow Tesla to sell more cars going forward than it has in the past. Its new battery factories  in China and Berlin, will help boost its international sales.

But where the Q3 report truly helped Tesla stock was on the profitability front. Tesla increased its gross margin despite lower sales, with the company’s 10-Q filing specifically highlighting “improvement of manufacturing efficiencies.” Some bears thought warranty adjustments raised the company’s profits, but, as with all things TSLA, that argument has been disputed.

In any event, Tesla’s Q3 profit was still impressive, at least relative to expectations. Its earnings per share, excluding some items, did decline 37% year-over-year.  But its EPS of $1.91 surprised analysts who, on average, had expected a loss.

Those earnings create an intriguing bullish argument. Specifically, if Tesla can drive a profit now and improve its margins, surely its earnings will get even better as it expands to new markets  and its sales rise.

The Problem With TSLA Stock

In that context, the steady rise of Tesla stock makes some sense. And from a near-term standpoint, the chart of TSLA stock suggests more gains ahead. That said, there are reasons to be cautious about TSLA stock as well.

One key concern is that chart. TSLA stock historically has struggled when it’s cleared $350. The shares closed above that level for the first time on June 6, 2017, and stayed above $350 for nearly a month. Another rally in August 2017 lasted ten sessions before faltering. In the 28 months since then, Tesla stock has closed above $350 16 times. It never stayed above $350 for more than ten trading days; on average, TSLA stock fell below that level in  fewer than four sessions.

Many investors  have been persistently worried about the valuation of TSLA stock. And that concern still has some validity. TSLA stock is trading at 34 times analysts’ average 2021 EPS estimate. By comparison,  U.S. auto manufacturers Ford (NYSE:F) and General Motors (NYSE:GM) trade at single-digit multiples.

Obviously, the relatively low valuations of Ford and GM are due in part to Tesla’s threat. Both companies are well behind TSLA in electric vehicles. By the same token, an investor wouldn’t call a retailer like Kohl’s (NYSE:KSS) “cheap” simply because it trades at a big discount to Amazon.com (NASDAQ:AMZN). When one company is taking sales from another, it should trade at a substantial premium to its struggling rival.

Still, with Tesla stock above $350, it’s pricing in consistent, impressive growth. And it’s fair to wonder to what extent Tesla can deliver on that. The automotive business is brutally competitive and notoriously cyclical. Tesla’s solar business is close to immaterial at this point, with its revenue this year tracking to under $1.5 billion. Investors have worried about the valuation of Tesla stock at these levels in the past, and they may do so again.

Is This Time Different?

As the common financial industry disclaimer notes, past performance does not guarantee future success (or failure). TSLA stock is breaking out at the moment, and its chart looks positive.

But Tesla’s Q1 delivery report looms at the beginning of next month. There could be some delayed profit-taking as investors who bought Tesla stock on weakness last spring wait until spring 2020 to sell their shares so they can pay lower taxes on their gains.

And, again, history suggests that when one side of the TSLA debate wants to celebrate, it instead should start to worry. That was the case for bears in May, who thought their concerns had been validated. Bulls should at least consider the possibility that their time for caution has arrived.

As of this writing, Vince Martin has no positions in any securities mentioned.

 

 

 


Article printed from InvestorPlace Media, https://investorplace.com/2019/12/careful-tesla-stock-been-here-before/.

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