The Tesla Dilemma: To Sell or Not to Sell?

"Our favorite holding period is forever," Warren Buffett has famously said. But even the Oracle of Omaha sells stocks at times. He has even expressed regret in not selling his beloved Coca-Cola stock when it became wildly overvalued in the late '90s. In reference to its wild run-up, Buffett confessed his mistake in the 2004 Berkshire Hathaway letter to shareholders:

Berkshire's results would have been far better if I had caught this swing of the pendulum ... I can properly be criticized for merely clucking about nose-bleed valuations during the Bubble rather than acting on my views. Though I said at the time that certain of the stocks we held were priced ahead of themselves, I underestimated just how severe the overvaluation was. I talked when I should have walked.

So what is the best practice? Should you let your winners run? Or should you cash out when your stocks become overvalued?

For investors in Tesla Motors (NASDAQ: TSLA  ) , these are serious questions and merit thoughtful exploration. Up more than 500% in less than 12 months, Tesla's valuation is getting ahead of itself. But what should shareholders do?

Selling strategies
There is no black and white answer on when an investor should sell a stock. There are, though, the two extremes:

  1. Sell stocks when they become overvalued.
  2. Let your winners run as long as your investment thesis remains intact.

However, as is the typical problem with extremes, they may be too extreme. Let's examine both approaches.

Letting your winners run is helpful in minimizing capital gains taxes. Even more, it reduces portfolio turnover and means your portfolio may not require as much attention. And probably the best of all, it enables your best stocks and their underlying businesses to outperform your expectations. Why pick the flowers in your garden when you should be watering them and pulling the weeds instead? Finally, it could even be argued that having such an extreme mindset could evoke superior analysis and wiser investment decisions since you could be holding the stock for a very long time.

The biggest problem with Selling overvalued stocks, of course, is that you may find yourself frequently selling your best-performing businesses much too early, missing out on nice gains. But the problem with this strategy goes deeper than that.

To assert that a stock is overvalued, you're going to need an estimate of the company's intrinsic value -- and this isn't easy. Selling overvalued stocks, therefore, introduces a greater need to keep tabs on a company's intrinsic value. To make matters more difficult, that value changes over time.

Before Tesla's first quarter, for instance, the company's ability to significantly ramp up production on its new Model S was nothing but a hope for investors. After it reported first-quarter earnings, however, the story totally changed. And soon after, intrinsic value looked better again as the company paid off a massive government loan and raised about $1 billion in new capital. Clearly, keeping tabs on intrinsic value is hard work.

But there are benefits to selling stocks when they appear to be overvalued. Mainly, it allows you to free up cash invested in overvalued assets, reallocate that money into undervalued stocks, and thus boost the total intrinsic value of the assets in your portfolio. Easier said than done, of course.

A middle ground
Why not find a middle ground between both approaches? Why not hold your slightly overvalued, excellent businesses, but sell your grossly overvalued stocks?

Value investing guru and blogger Greg Speicher explored this same dilemma and eloquently highlighted a compelling middle ground:

I am a strong proponent of patient business-like investing for the long-term. This is a proven way to create wealth. However, at a sufficiently high price, all assets -- no matter what their level of quality -- should be sold.

He goes on to suggest that investors should put "a premium on hard work, exceptional research, and following a rational investing process with great discipline," and cash out on their grossly overvalued stocks.

But what is grossly overvalued? When the company's price "exceeds all reasonable estimates" of its intrinsic value, he says. This answer still leaves a lot of gray area. What is the highest reasonable estimate for Tesla's intrinsic value? For me, it's below $190 -- and that's why I've recently sold the stock. I laid out what I believe to be a reasonable best-case scenario for Tesla's business -- 500,000 cars per year in five years and a 30% gross profit margin -- and I found even this bullish scenario is already priced into the stock. But thanks to so much gray area between different selling philosophies and estimates for Tesla's intrinsic value, you'll be better off making the final decision based on your personal research and opinion, not mine.

Whatever you decide about Tesla stock, the scenario serves as an interesting case study. After examining both approaches and being forced to make a decision with my real-money portfolio, I believe the best approach is found in the middle: Invest with the intention of holding for decades and let your winners run -- but not too far.

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Read/Post Comments (36) | Recommend This Article (33)

Comments from our Foolish Readers

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  • Report this Comment On October 02, 2013, at 1:20 PM, CaSmiles wrote:

    Tesla is founded by a person who can be counted on to pull a rabbit out of a hat; he's done it many times already. That said, I am taking a middle "middle" ground, and selling 1/2 my holding. That way I'm still invested, but I'm playing with the market's money.

  • Report this Comment On October 02, 2013, at 2:01 PM, TMFDanielSparks wrote:

    @CaSmiles

    Sound reasoning. That was my second choice... I debated for a while.

  • Report this Comment On October 02, 2013, at 2:17 PM, MartyTheCanuck wrote:

    I also decided to sell half my TSLA, because it now represented a too large position in my portfolio ( 15% ). It was getting uncomfortable for me. My average cost was 45$, I sold half at 162$.

  • Report this Comment On October 02, 2013, at 5:10 PM, Seanickson wrote:

    Sell, Sell, Sell. Theres no room for these kind of margins as electric cars become more mainstream. The auto market is very competitive and if tesla has found a better way, it will be copied quickly.

  • Report this Comment On October 02, 2013, at 5:26 PM, schreibs wrote:

    I bought Tesla at 89 and sold at 101 after reading the Barron's article (4 months ago) which said it could easily drop to 50 since it was overvalued (at 101!!!). I didn't want to tempt fate and turn a small profit into a large loss. Groan. Good for y'all at 190+.

  • Report this Comment On October 02, 2013, at 5:30 PM, user5701 wrote:

    I love the contradiction in your story. Daniel says to get out, but yet you see "The Motley Fool recommends ... Tesla Motors. The Motley Fool owns shares of Tesla Motors." Sorry Daniel, but Tom disagrees with you.

  • Report this Comment On October 02, 2013, at 5:32 PM, michigancargirl wrote:

    It's the next Google. We haven't even begun to see infrastructure put in place other than in CA for "fill-ups". I'm in for the ride- I predict it's up, up and away!

  • Report this Comment On October 02, 2013, at 5:41 PM, Tomtherailnut wrote:

    Rule Number 1 - Don't lose money!

    Tesla has awesome technology and brains in the CEO office, but unless it actually starts selling a lot of cars (something the traditional auto companies are good at but something TSLA has not proven to be able to do), the bloom will be off. Once there is a pull back on the stock price, all the lemmings will run for the cliff!

    Take your gains, hold some if you want to ride it for a while, but unless sales start supporting the business without tax benefits to make a profit, TSLA is always at the whim of the tax wizards in Congress - yes, those nice folks who can't decide whether they want to be in the "governing" business or not!

  • Report this Comment On October 02, 2013, at 5:59 PM, divebonaire wrote:

    This is a dilemma, whether or when to sell. Since you don't want to miss further gains you can hold on too long. I've ridden several stocks up and then back down when I didn't get out early enough. Two possible solutions - sell to recoup initial investment + taxes and let balance ride or set up a trailing stop to continue to capture future gains but to trigger a sale if the stock drops a pre determined amount - I usually use 20-25%. If the stock continues to rise you have to keep moving the stop up but you lock in gains.

  • Report this Comment On October 02, 2013, at 6:23 PM, bobbyk1 wrote:

    I sold today and bought more CSTE.

  • Report this Comment On October 02, 2013, at 6:38 PM, EducatedGuesser wrote:

    I am holding till the next earnings report as I am confident Elon will outperform again as always. As for those who think what Tesla's success can be copied quickly, I disagree. Tesla is a brand new company and the production process is almost completely automated (I.E., run by Robots). Which means less costs than a factory run by Chinese labor; and who says China can copy their manufacturing process? Sure, you can deconstruct a car and reconstruct it, but you can't deconstruct the Tesla factory and reconstruct it; and that is how Tesla has owned the competition thus far. Have you read the articles about 3D printers and how they will put the Chinese out of work? This is essentially the same thing. Either way, I look forward to seeing you all in your electric cars 10 years from now!

  • Report this Comment On October 02, 2013, at 6:56 PM, RobertC314 wrote:

    Anyone remember who the famous invest was that, when asked how he made money in stocks, he answered that he always bought too late and sold too early?

  • Report this Comment On October 02, 2013, at 6:56 PM, RobertC314 wrote:

    famous investor* (sorry)

  • Report this Comment On October 02, 2013, at 6:57 PM, xetn wrote:

    There are some really interesting data buried in the attached article. Like:

    "Turns out the Tesla is the third best-selling high-end car in California (where it doesn’t get too cold, an important consideration for an electric car) just behind the Mercedes-Benz E-Class and the BMW 5.

    Sounds good – and is touted that way by the moo-cows of the media. But how many cars did Tesla actually sell?

    So far, about 4,714. Out of about 1.6 million cars sold in California annually."

    For more:

    http://ericpetersautos.com/2013/09/24/madness-gm/

  • Report this Comment On October 02, 2013, at 7:01 PM, tombland wrote:

    @schreibs – Disappointing to hear you sold Tesla because of what you read in a Barrons article. They have have had an agenda against Tesla and Elon Musk for a while. I'm no expert but I'd say the moral of the story is that whether it's Barrons or Motley Fool – don't react in a panic to things that you read. On that basis I'm holding Tesla for the long run.

  • Report this Comment On October 02, 2013, at 8:46 PM, Ladanova wrote:

    First fire in a Tesla Model S burns $600 million off the company's value

  • Report this Comment On October 02, 2013, at 11:57 PM, chucke63 wrote:

    Remember a man by the intials SJ he built a box that ran on electricity and look where his company is today. A person with a passion who invests his own assets, passion is some one I back. I agree with most comments presented here today don't put all your eggs in one basket, I feel Tesla has more growth.

  • Report this Comment On October 03, 2013, at 12:42 PM, moleque wrote:

    I have no position in Tesla, but did work in the auto industry for 26 years. I view Tesla as an extremely risky investment, at any price, for three main reasons:

    First, it is an auto company. Therefore, it is competing with giants who can pour their money, factories, technology, and dealer networks into electric cars. Second, Tesla is crazy enough to be headquartered in California, when the smart auto money is investing in right-to-work states. If Tesla gets to be successful, the UAW will drive it into the ground, with outrageous work rules and salary demands-- like it did Chrysler and GM. Third, Tesla is small and to make money producing autos, you need to have economies of scale-- which Tesla will have a hard time ever attaining.

    In addition, all it will take is a few more car fires to bury the company-- whether or not the fires are really due to a defective design. Just look at Toyota and the alleged unexplained acceleration. Just wait until somebody's house burns down in a garage fire or somebody is incinerated in an accident.

  • Report this Comment On October 03, 2013, at 1:06 PM, Risky88 wrote:

    UAW has nothing to do with GM being successful. Look at Ford and GM today!

    its called SELLING CARS!

    Its not good to lose your number spot, especially to a foreign company.

  • Report this Comment On October 03, 2013, at 2:10 PM, YeoKC01 wrote:

    Very helpful article and subsequent posts (well mostly :) ). Pretty novice investor w/ pretty high tolerance for risk & a fool subscriber for approx 1 yr. TSLA is my first big winner so far. bought @ 2 yrs ago w/ expectation of holding 20 yrs if the firm's tragectory/story remains true. sold 5% of my position at approx 7-bagger status recently not because I doubt the trueness of the trajectory but rather because TSLA has so outperformed the rest of my portfolio that I felt my overall portfolio was getting a little unbalanced. I'll feel compelled to let go of another 5% of the position if it reaches 10-bagger status before end of next yr for the same reason even if TSLA's story/fundamentals remain unchanged.

    So far after an initial review of the report about the recent Model S fire incident I'm still feeling confident in this firm long term. Many have compared Musk to Jobs and Teslamotors to Apple & I understand that the SiliconValley connection makes this comparison that much more appropriate. However I feel the better comparison may be TSLA vs TM. So far I'm still seeing all of Tesla's competitors, blinded somewhat by their legacy IC-based culture, behave in much the same manner that we witnessed the big 3 automakers respond to TM's march into the market (back in the 70's?) with their smaller, more fuel efficient models. Fellow fools and/or potential TSLA investors having trouble recognizing this phenomena in replay may be well served to revisit the classic book "The Innovator's Dilemma".

  • Report this Comment On October 03, 2013, at 2:49 PM, sailrmac wrote:

    "I am confident xxx will outperform again as always."

    If that's not a signal of overconfidence, I don't know what is.

  • Report this Comment On October 03, 2013, at 3:04 PM, MelissainVA wrote:

    I sold my shares for 100% profit a few months ago and I have been watching from the sidelines since then wondering whether or not it was the right decision but also being unable to fathom how it could possibly be correctly valued at $180+.

    But I don't like it when articles like this directly contradict SA recommendations and there is no explanation. I am very happy with SA for the most part but these sorts of contradictions always raise doubt for me.

  • Report this Comment On October 03, 2013, at 3:44 PM, AltReality11 wrote:

    I've taken a different route for a "middle ground" similar to some of the comments.

    When I purchase a stock I set performance goals. If the stock reaches it, I re-evaluate. If it exceeds by a significant percentage, i then consider if my premise is right or wrong.

    If I decide my premise is right and I've exceeded my targets, I may sell a stake and take a small profit. The rest of the stock I let ride. At that point I've removed my risk capital. I then use that to buy something else that is attractive.

    There are almost always some opportunities.

  • Report this Comment On October 03, 2013, at 4:09 PM, Fabin81 wrote:

    Honestly, I starred at this stock this morning thinking about the possible outcomes. Should I short this stock. Should I buy a put. Then I was honest about it and knew, anything I did was pure speculation and buying a put would be a $2000 bet. Just decided to stay away and let the market do with it as it pleases.

  • Report this Comment On October 03, 2013, at 4:42 PM, damilkman wrote:

    I was an AOL employeee many moons ago. They had this not employee stock buying program. Bought at the right and saw more doublings then a cancer cell. My few K was soon worth over a quarter million dollars. I'm a 20some punk and I don't even know what to do but be greedy. I of course held on and saw 90%+ of my profit disappear. If I had been smart I would have sold half and had my house paid in full or whatever I wanted to do with it. 15 years later I did the exact same thing when my modest investment in American Superconductor blew through the roof. Learning nothing I held despite the fundamentals warning they they were dependent on one company for all of their revenue.

    The moral of the story. If you bought low, lock in some winnings. If you still believe long term you can keep half and see what happens. Don't get greedy as double or nothing sometimes happens.

  • Report this Comment On October 03, 2013, at 4:50 PM, TMFJebbo wrote:

    I bought TSLA once at $32 and again at $40. I didn't really want to sell any of it, but when it hit $190 I sold the part that was in an IRA. I'm ok with locking in the gains when there is no tax consequence. If there were short term capital gains on top the sell decision that would make the decision that much more difficult.

    Jeb

  • Report this Comment On October 03, 2013, at 5:29 PM, awallejr wrote:

    Main thing when riding a momentum stock, the minute something bad hits (doesn't matter what) they can drop like rocks. At least take off half your gains.

  • Report this Comment On October 04, 2013, at 1:08 PM, Truth2Power wrote:

    Interesting that most of the commentary seems to be centered around whether to sell or not. Is there anyone contemplating BUYING at this price/valuation?

  • Report this Comment On October 04, 2013, at 2:31 PM, mikecart1 wrote:

    I'm not a shareholder of TSLA - yet. I have followed since IPO and somewhat mad not getting in the $30's. However, what has me debating on buying even now at much higher prices is that I was in a parking lot earlier this week in the DC metro area.

    What was in this parking lot?

    3 Telsa S Models. Yes! THREE!

    What is so great about this? I've never seen one before outside of a dealership. Interesting!!! :)

  • Report this Comment On October 04, 2013, at 3:12 PM, cjloki wrote:

    a couple of years ago i was able to buy some tsla shares starting from the ipo and beyond into early 2013. When tsla hit 40.00 i sold my 185 shares in order to pay off a debt, and then within days the boom began, ... if i had been able to hold the line and keep them i would no longer be worrying about the bill or much else for that matter,...these days i spend my disposable trying to rebuild my tsla, but at this stage, my accounts would probably be better off if i had a worthy alternative with similar potential :(

    i'm certain ben graham is rolling in his grave

    cj

  • Report this Comment On October 04, 2013, at 4:24 PM, JCoeur wrote:

    Pigs get slaughtered.

  • Report this Comment On October 04, 2013, at 10:15 PM, circa1850 wrote:

    My very first investment happened to be the hottest stock of the year, 1989 or so. I only purchased it based on a local business rag and liking the conservative bent of the CEO. It rode from $6.00 to $160.00 in a year. Every day I'd open the stock page of the paper and was $1000-$2000 richer. Greed ensued.

    Did sell enough to preserve my initial investment of $2000, but lost a bundle when it tumbled back to my purchase price. Dumb, but I loved the stock and the business and thought it would stablize and come back some more. It didn't.

    Take some profit! Hold a stake if you must.

    p.s. Have you ever seen a gas powered car burn? How many times? TSLA rebounded today.

  • Report this Comment On October 06, 2013, at 4:24 AM, ahart12 wrote:

    My strategy is to let the market do the hard work for me. It is psychologicaly easier and you do not end up blaming yourself for wrong decisions.

    I bought Tesla at 31. It is now 15% of my account and I do not want any single stock being more than 4-5% of my account. So I placed an order to sell half my position at 2 pivot points below current price, at about 157. If the price goes up I'll stay in and move my stop higher as a get higher pivot points. If the price goes down I still lock some profit and stay in with smaller position for the long run. It is always better (emotionally) to exit partially a position when you think it is overvalued.

  • Report this Comment On October 08, 2013, at 4:07 PM, whyaduck1128 wrote:

    I bought some at 36, looking for a quick profit after the NYT hatchet job. Set a selling price of 54, figuring a quick 50% gain was nothing to be depressed about. Sold at that price and look what happened subsequently.

    Do I regret selling? Not really. I made some quick money on a stock that I bought as a GAMBLE, not an investment.

    Would I buy it again? You bet. I have an order in to buy it should it drop about 25%. This time it would be an investment, though--buy and be patient.

  • Report this Comment On October 15, 2013, at 2:11 AM, VetteGyrl wrote:

    I bought healthy amount at about $35 with the intent of keeping it for the long term. It promptly dropped in excess of 25% and stayed there for a while, but I wasn't worried. I believed. Once it was bouncing around $150 it was hard not to sell it all! But, I believe in Tesla as a company and a technology. I did not want to sell it all. So, I did the calculations and determined the amount to sell that released my entire initial investment but left at least 1/2 to ride until the end of my life, or the companies, whichever came first. =) I still own a good share and I am happy that my initial "profit" is all I have in the company. I needed to diversify and this was a great way to keep this investment and accomplish my goals.

  • Report this Comment On October 17, 2013, at 8:09 AM, Myslo wrote:

    Quick Background: I love Tesla Motors, and have a B.S. in Economics. I am currently long in Tesla.

    The only thing limiting Tesla's sales today is Elon Musk.

    The demand for a "Model S" is still growing in the U.S as more people learn about Tesla and fears and misconceptions (such as "range anxiety") about electric vehicles are sequestered... Furthermore, international availability and demand is only now just starting to grow.

    More patents have been registered and/or purchased (for instance, battery tech.) by Tesla. More super-charger stations exist than ever before, with much more on the way.

    Workers at the assembly line at the Tesla plant have tweeted that production of the model-s could be easily be increased by adding more shifts to production (following in the footsteps of many other auto-makers). So why has this not been done yet?

    In my opinion, Musk is purposefully increasing production slowly, so that each quarter the company will be able to post greater than expected earnings! While the brand grows (and while the "amazing track record" is slowly solidified in the minds of consumers around the globe), Musk will be quietly working out the "kinks", as well as establishing a global network of supercharger stations, and maybe even newer (more sophisticated and efficient) new auto-plants.

    Despite a consistent track record for outperforming analyst expectations, his goals are not short-term.

    Still, investors are confused because of a number of reasons. One issue is the spread of price-points given to Tesla by different firms. In my opinion, this large spread is, for the most part, due to the differences in time frames different firms are using to evaluate Tesla. Those who are looking to estimate a value for Tesla in Today's market make up the lower bound, around (estimated) $170 per share... versus those who see the companies value in a few years (estimated) $210 per share... and finally, those who see Tesla for what it Could be in 8-10 years from now (Estiamted) Over $240.

    I expect Tesla to do better... quicker.

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