It is human nature to doubt new things. New things are often created by de novo companies with no discernible competitive advantages. These are the companies founded by people with wild hair and wilder ideas. Start-ups face competition with orders of magnitude more resources, experience, and connections.
Due to those factors, it is very normal for investors to doubt the up-and-comers. There are virtually no successful technology companies today that haven't had their doubters at times. Google was said to be just a feature, not a product. Amazon was just an online book seller.
The two companies have their doubters as well. Shorts currently make up more than one in five SolarCity shares and one in three Tesla shares.
The doubters have been proved wrong so far in light of the rallies both stocks have experienced -- but whether the doubters will be wrong in the long term is an extremely contentious debate.
A tale of two different philosophies
There is one school of thought, mainly held by venture capitalists and growth investors, that believes investing successfully is all about focusing on the quality of the product, the size of the potential market, and the character of the leaders. Those investors are not as concerned about the competition because they believe if one just focuses on the road ahead rather than worrying about the competition, they will do just fine. As long as companies can innovate and lead the way, there is no reason to fear the competition that is always one step behind.
The other school of thought, mainly held by more conservative investors, puts more emphasis on quality of competition, probability of success based on historical analogies, and growth-adjusted valuation numbers.
Not surprisingly, Tesla and SolarCity shares show the tension between the two schools of thought. The venture-capital-minded investors are mainly long, while the more conservative investors are mainly short.
Good reasons for both sides
There are good reasons behind both views. That is, after all, what makes a market.
Tesla does have a great product. The Model S was given the 2013 Motor Trend Car of the Year award, and users rave about how well the car handles. It's a huge market as well. The global car and automobile market is a $4 trillion a year market.
SolarCity has an equally great product. The company essentially offers cheaper electricity than utilities while saving the environment. The utlility market is also huge. U.S. power utilities sell $400 billion in electricity every year.
Elon Musk, who is chairman of SolarCity and CEO of Tesla, is the proverbial Thomas Edison of our time. The two companies are still growing at extremely fast clips.
On the other side, the shorts think the valuations are absurd. The stocks are rallying in what has generally been a bull market, and the two companies have good stories to tell. Part of the reason the advances have been so extreme is that both are crowded with short trades, creating a short squeeze.
The two companies also still depend on generous government subsidies. Some shorts think that when the established car companies get their EV game on, it will be game over for Tesla.
The bottom line
I believe a significant portion of the float of both stocks is made up of momentum investors that could go one way or the other. The momentum investors are the proverbial sharks following the sheep: They will leave at the first sign of trouble. Whether that trouble will come is still up for debate.
The success of the companies depends on how fast battery technology advances and how generous the government subsidies will be down the road. Those factors, and the ultimate success of both companies, are unknowns today. Another critical ingredient for success is the public perception of Elon Musk and his projects. On that count, Mr. Musk and his two companies are doing just fine.
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Jay Yao has no position in any stocks mentioned. The Motley Fool recommends SolarCity and Tesla Motors. The Motley Fool owns shares of SolarCity and Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.