Back on June 30, I wrote about how Nikola (NASDAQ:NKLA) was grossly overvalued and a dangerous speculation. In less than two months since that story, the stock is down 36.3%. I still think NKLA stock, Tesla (NASDAQ:TSLA) stock and other electric vehicle stocks are caught in a market bubble.
I’ve repeatedly told investors to stay away from Tesla, Nikola and other EV stocks. At least stay away until the bubble deflates a bit more and the valuations come back down to earth.
However, savvy investors can take advantage of a technique known as pair trading to buy Tesla today, even at its current ridiculous valuation.
What’s Wrong With TSLA Stock At $1,400?
TSLA stock has already taken a big hit since late July. The irrational exuberance for the stock seems to have started to fade. But Tesla still has a long way to go to the downside before it is reasonably valued. Tesla trades at about 91.2 times forward earnings. Auto competitors Ford (NYSE:F), General Motors (NYSE:GM) and Toyota (NYSE:TM) trade at an average forward earnings multiple of 9.9. Tesla trades at 10.5 times sales. Ford, GM and Toyota trade at 0.43 times sales.
But since Tesla bulls argue that the company is the next tech giant, like Amazon.com (NASDAQ:AMZN), Facebook (NASDAQ:FB) or Apple (NASDAQ:AAPL), let’s make another comparison. Those tech stocks have an average forward earnings multiple of around 42, a more than 50% discount to TSLA stock. They also trade at an average price-to-sales ratio of 7.35, a 30% discount to Tesla.
Tesla isn’t the only stock caught in the EV bubble. There are dozens. But Nikola may be one of the most egregiously valued of all. I’d love to compare Nikola’s earnings and sales multiples to Tesla’s, but Nikola has none. Nikola essentially has no earnings or sales to speak of.
Why Tesla Over Nikola?
In a vacuum, I think investors should stay away from TSLA stock for a number of reasons. Valuation is simply the biggest. But compared to Nikola, Tesla looks like a dream investment.
Essentially, both Tesla and Nikola are story stocks. Story stocks aren’t valued on the viability of their business models, their growth and profit metrics or the health of their balance sheets. They are valued based on the stories the company tells investors about how great things will be in the future. For example, Tesla’s revenue was down 4.9% in the second quarter despite launching the Model Y and the opening of its China gigafactory. But just look at how many products the company has in development. Cybertruck, semi truck, Roadster, fully-autonomous Autopilot, and now (not kidding) Tesla spaceship are all in various stages of research and development.
I’m always skeptical of story stocks because they tend to price in the perfect storybook ending before the end of the first chapter of the book. I wrote that Nikola was already priced to perfection back in July. But Tesla and Nikola are both story stocks, and they both have the same story. Investors are betting that these tiny companies with negligible or nonexistant global market share will eventually grow to dominate the world auto market over time.
Like I said, I’m skeptical of that story. But if somebody asked me which company is more likely to make that fairy tale come true, it’s got to be Tesla.
How To Play It
For the record, I’m not a fan of TSLA stock at all. In fact, I think there’s a strong possibility stock could underperform over the next 10 or 15 years.
But this trade isn’t about if Tesla will be trading at $20 or $2,000 in two years. It’s strictly about Tesla outperforming Nikola.
I’m recommending traders go long TSLA stock and short Nikola. Nikola likely has a bright future of long-term growth ahead of it. But its market cap of $16.3 billion is crazy considering the company doesn’t even have a product on the market at this point.
Nikola and Tesla are two story stocks with the same story and the same happy ending. But if the growth story is a 300-page novel, Tesla is on page 25, while Nikola is only on page four. If Nikola wins in the long-term, I’m betting Tesla will win bigger. And If Tesla loses, I’m betting Nikola will end up worthless.
Wayne Duggan has been a U.S. News & World Report Investing contributor since 2016 and is a staff writer at Benzinga, where he has written more than 7,000 articles. Mr. Duggan is the author of the book Beating Wall Street With Common Sense, which focuses on investing psychology and practical strategies to outperform the stock market. As of this writing, Wayne Duggan was long GM.