Here’s Why Short Sellers Are Shorting Tesla

For the last several months we’ve been organizing the 1,700+ articles here on Nanalyze into a handy set of guides for our readers. (You can access these using the dropdown in the upper right-hand corner of this page.) During that process, we realized that we’ve never written about Tesla, aside from a few green tech pieces on their Powerwall home battery and solar energy aspirations. There are two main reasons for that.

Firstly, we believe Tesla stock presents far too much risk (volatility) than we are willing to stomach as risk averse investors. Secondly, the last thing everyone needs is another opinion on Tesla. Still, we expect that any number of our premium subscribers have skin in the game, so we decided to pontificate a bit. Since we have no dog in the race, we’ll try to take an objective look at Tesla’s recent share price appreciation.

Why Are Tesla’s Shares Rising?

If you haven’t been watching Tesla’s share price, here’s a visual depiction of what’s been happening.

Credit: Bloomberg

For the past five years, shares of Tesla would flirt with highs around the $350 -$370 dollar mark. That was until about the middle of December 2019 when shares began to break out. In just one year, Tesla’s shares rose +518% while the Nasdaq rose just +27%. They even steamrolled right over “the rona,” having gained +262% since news of the pandemic first struck.

While some people are claiming Tesla’s meteoric rise is just “institutions waking up to the incredible potential of electric vehicles and autonomous driving,” the efficient market hypothesis begs to differ. The big question to ask here is this:

What information made public in the past year justifies a +518% increase in Tesla’s share price?

Sure, deliveries improved in the second half of 2019, and the company surprised Wall Street by posting a first-quarter profit. But, does any of that explain the +518% share price increase and accompanying volatility? If the answer is no, and you have cajones of hardened titanium, then you might consider shorting Tesla.

How Do You Short Tesla?

If you’re not familiar with how short selling works, here’s a quick primer.

If we believe Tesla shares will drop, we can borrow shares from our broker. Let’s say we borrow one share of Tesla at $1,500 a share and sell it immediately to some weekend warrior over at Robinhood. We now owe our broker one share of Tesla and we have $1,500 in cash. Here are a few possible outcomes:

  • If the price drops to $1,000 a share, we can then go buy a share for $1,000 and give it back to the broker. We’re left with +500 in cash to spend at the gentleman’s club.
  • If the price rises to $2,000 a share, we may start to get worried and decide to close out our short. We then buy a share for $2,000 and our cash position is -500 dollars. In other words, we lost $500 on that trade.

Anyone can short Tesla provided their broker extends them margin to trade with. Margin is when you put up collateral against your position. In other words, everything in your brokerage account could be liquidated if you run up enough debt on a bad trade.

Many Tesla short sellers are speculating – justifiably – that Tesla’s shares are temporarily overpriced. When a stock rises +332% in four months for no apparent reason, it’s almost always hype that’s under its wings. Inevitably, shares revert back to the mean. Still, people who are short selling Tesla in the short term are not investors, they are speculators.

We’ve said many times before that the irrationality of the greedy herd will always be greater than your margin account limits. No matter how high that price rises, it can always go higher. When it goes high enough that the short sellers panic and go to cover their short positions, the price gets driven even higher (this is called a short squeeze). Unless you work at a hedge fund where your job is to short companies, you should never try to short any company you think is overpriced. It’s pure speculation and far too risky.

If you think a stock is overpriced and you’re already a shareholder, simply start to slowly trim your position. This will cost you nothing, since brokers removed transaction fees from the equation. Just sell 10% of your position every time the share price goes up by another $100. Of course, there are others out there who believe you should sell all those shares because they’ll eventually be worthless.

Shorting Tesla to Zero

There’s also another type of trader shorting Tesla. There are people out there who believe – or at least claim to believe – that the stock is worthless. We came across a 101-page thesis on why Tesla is worthless, written by someone who seems to have a bone to pick with Tesla and Tesla founder Elon Musk. It’s a well-composed – if not verbose – document that sits on the extreme edge of critical viewpoints with accusations of “criminal behavior.” If there was any red flag out there worth looking at, this report would probably mention it. So, we pored through all 101 pages of the report to extract any insights that might help us understand why Tesla’s stock could be worth a whole lot less than it is now.

Elon Musk’s appearance on the Joe Rogan Show made it clear that he’s a man who doesn’t like to play by the rules, and that makes him an easy target for his enemies. The first part of the report is a collection of “gotchas” that paint Elon Musk as an unhinged risk taker, someone who masks his dictator-like persona in humor, a man who demands the absolute best out of every employee who works for him.

But enough about Mr. Musk’s finer qualities. We all know it’s hero or zero for the man with so many distractions we can barely keep track of them all – SpaceX, Neuralink, Solar City, home batteries, the Boring Company, selling short shorts, Hyperloop, – the list goes on.

The report also paints a picture of a convoluted financial structure of shell companies behind the scenes which may mask some of Mr. Musk’s financial dealings. (First world problems.)

The story continues with details of the famous “Am considering taking Tesla private at $420. Funding secured” tweet. Anyone who puffs the magic dragon would have smelled a skunk here, but nonetheless Mr. Musk had his hand slapped by the SEC with some fines. Then there’s any number of things he said in earnings calls that were misleading or inaccurate or false claims – like buying a Tesla is “an appreciating asset—not a depreciating asset.”

The document then goes into the dangers of Autopilot and the accompanying lawsuits that you’d expect from the ambulance chasers. Then it goes back into more misleading statements from Musk about how much progress has been made on vehicle autonomy. Says the author:

Musk clearly uses transparency to his advantage, preaching the value of openness when it is convenient and secrecy when it is not. He is hardly the only Silicon Valley CEO to do so.

The next part of the document mentions something a Morgan Stanley analyst said that strikes true:

No one really cares about debt. No one cares about the [credit default swaps] as long as you’re growing. When questions are called into your growth these numbers start to be noticed.

Then apparently the analyst went and upgraded the stock or something, which if you’ve ever worked at an investment bank, you’d understand why their analysts say one thing and then do another. Still, that statement does raise a good question – have revenues been slowing? Here are the quarterly and yearly revenue charts from Yahoo Finance:

Credit: Yahoo Finance

You could certainly argue that revenues are temporarily slowing based on the above charts. It’s something investors should be watching closely.

Then the report goes into product defects like cars exploding or rear bumpers falling off in the rain (happened just hours ago actually), all of which is accompanied by the mandatory photo of a car exploding.

Insert scary-looking pictures here

You’d like to think that since Tesla is building their cars with industrial robots, they’ll quickly be able to work out the kinks. The same holds true for service problems. It’s all part of the teething process for any new automotive company.

Then there’s the section titled “A Culture of Secrets, Fear, and Abuse,” which should sound familiar to anyone who’s served time in a large multinational corporation. So should the departure of executives over time, something that is not uncommon in other firms where the CEO also happens to be the Chairman of the Board (after the SEC tussle, they appointed Robyn Denholm to the role).

The report then names and shames a whole bunch of Tesla fanboys and criticizes Ark Invest for setting unrealistic price targets for Tesla while trading the stock. There’s also a suggestion that they’re in cahoots in some way. (More on this in a bit.) Then there’s a section on perceived accounting issues which mimics the concerns raised by David Einhorn of Greenlight Capital, mainly questioning Tesla’s billing practices and accounts receivables. Like the report’s author, Mr. Einhorn also has put options on Tesla. (Put options are a very risky way to bet that a stock price will fall.)

Finally, there’s a section titled “The Trouble With Elon Musk” which talks about things like the doobie he smoked on Joe Rogan, his private jets, and his extremely high opinion of himself. After these compliments, the author then goes on to criticize Musk over half a dozen other things that eventually start to sound like your spouse nagging you about when you’re going to replace the roof.

101 pages is a lot to digest, but that’s about the gist of it. We’re not comfortable linking to the report, because we’re not in the habit of giving a pulpit to someone with an axe to grind. If you’re a premium subscriber, drop us a note, and we’ll send you the link if you want to go down that rabbit hole.

The Other Side of the Trade

You can be sure that Tesla’s legal team has given that 101-page document a read, along with any money manager with chips on Tesla’s table. One firm that’s probably read the piece – given they were bad-mouthed in it – is Ark Invest. The technology visionary behind the firm, Catherine Wood, believes Tesla’s shares could be worth 4X what they are today in five years’ time. Why? Because it’s not about electric vehicles, it’s about the $7 trillion autonomous driving opportunity.

“The winner in autonomous platforms, and in any artificial intelligence project, is that company with the most data and the highest-quality data,” she said. “That company is Tesla.”

Catherine Wood – Credit: CNBC Interview

All Tesla then needs to do is fight the litigation fires, fix the defects, keep their fearless leader in check, and eventually, they’ll become the leader in autonomous vehicles – again, a $7 TRILLION industry – because they already have 891,000 test cars out there gathering data and constantly improving their self-driving algorithms. That’s why Tesla is the top holding in the Ark Innovation ETF. As for the report’s criticisms of ARK’s trades, their ETF is an actively managed investment vehicle which could be playing this any number of ways as opposed to just long-and-strong. It’s also expected that Mrs. Wood would have met with Elon Musk since she’s really putting herself out there with these price targets.

The problem for retail investors who buy into the “Tesla will rule the autonomous vehicle industry” thesis is trying to figure out where to enter a position in Tesla or even add to one if you’re that bullish. Just solve that by using dollar-cost-averaging (DCA). Buy 10% of your target position now as a benchmark, then just do that nine more times over the next nine months. Really spread that purchase out and you’ll reduce market timing risk while taking the emotion out of the trade.

Be wary though of all the hype and volatility. There are 457,000 weekend warriors over at Robinhood that hold Tesla right now, and they’re trading the crap out of it. A few days ago, Bloomberg reported that 40,000 Robinhood accounts added shares of Tesla during a single four-hour span. It’s likely these Gordon Gekko proteges aren’t using dollar-cost-averaging, and consequently, their irrationality knows no bounds. This is the same lot that thinks a $10 stock is cheaper than a $100 stock. No wonder they love fractional trading so much.

Conclusion

You cannot just have exponential upside without the possibility for exponential downside. In order to capture a sizable piece of the $7 trillion dollar-autonomous vehicle opportunity, Tesla needs to beat all the other companies out there trying to do the same thing. And to do that they need to take risks – like deciding not to use LiDAR when so many other auto companies are.

We believe that it’s in the interest of retail investors to stay out of the fracas. You shouldn’t be shorting Tesla, and you shouldn’t be going long Tesla unless you’re doing it using DCA and the position is a small percentage of your overall portfolio. When you have such a dramatic difference of opinions about the value of a stock, along with the whole Robinhood trader lot climbing on board, you’re best staying away until the dust settles.

Just remember, less than four months ago shares of Tesla were trading at $351 a share. Today, they’re trading at over $1,500 a share. If the market takes a dump like it did earlier this year, nothing says it couldn’t test those levels again. If you bought shares today and it did, you’d be down -78% on your position. That’s why using dollar-cost-averaging with volatile stocks is so important.

Pure-play disruptive tech stocks are not only hard to find, but investing in them is risky business. That's why we created “The Nanalyze Disruptive Tech Portfolio Report,” which lists 20 disruptive tech stocks we love so much we’ve invested in them ourselves. Find out which tech stocks we love, like, and avoid in this special report, now available for all Nanalyze Premium annual subscribers.

Leave a Reply

Your email address will not be published. Required fields are marked *

  • This field is for validation purposes and should be left unchanged.
10 Shares
Tweet6
Share4
Share
Reddit
Buffer