As of Nov. 14, about 23.6% of Tesla Motors' (TSLA 1.85%) shares outstanding were sold short. That's close to 1 in 4 shares. Clearly, not everyone believes the company will live up to its $28 billion market capitalization. While the electric carmaker's optimistic valuation does raise eyebrows, I'm definitely glad not to be counted among those who have decided to short this fast-growing company.
Source: Tesla Motors.
But isn't it time to short Tesla stock now?
It's been a rough few years for investors who have decided to short Tesla stock. In the past 12 months, shares are up about 60%. Zoom out two years, and shares are up about 560%. But with shares up so significantly, some investors may think it's finally time for the Tesla shorts to get a little love. Indeed, Tesla stock is trading about 23% off its 52-week high -- this could signal the beginning of a downtrend, right?
However, before investors short Tesla simply because of a rosy valuation, they should think twice. Shorting purely on this basis may not be enough for a short position to make sense.
Consider this excerpt from John Del Vecchio and Tom Jacobs' book What's Behind the Numbers?:
"This book does not advocate or explain shorting or selling based on overvaluation...," explain John and Tom. "Why are these poor bases for shorting? Because overvaluation can continue indefinitely."
On what bases do the authors recommend shorting?
We recommend waiting until there is aggressive revenue recognition, weakening balance sheets, and deteriorating cash flow trends. It's the flipside of value-with-catalyst, which is fundamental analysis of value combined with a catalyst for stock market buying to boost the price to realize that value. ... So, too, on the short side. Wait until there are negative catalysts for profits in the near future -- a year or two at most, the rough time period that the value-with-catalyst investor seeks.
In other words, investors should look for signs of a deteriorating business. Tesla is quite the opposite. The company has no need for aggressive revenue reporting; 2014 vehicle sales are on pace to finish the year 46% higher. Headed into 2015, the company expects Model S sales to grow from 33,000 to 50,000. Add in Tesla's Model X, which goes on sale in the second half of 2015 and is already sold out for the year, and Tesla's total vehicle sales for 2015 may be around 100% higher than in 2014.
Model S (left) and prototype of Model X. Source: Tesla Motors.
Analysts, on average, are predicting Tesla will reach profitability next year, with a consensus estimate for $2.89 in non-GAAP earnings per share, up from estimates for $0.60 in 2014. While this would still only represent a tiny sliver of Tesla's $223 share price at the time of this writing, the carmaker's likely profitability next year serves as another sign Tesla doesn't fit well into the deteriorating business category.
Simply put, Tesla isn't quality short material. Sales are soaring, margins are expanding, and earnings are just around the corner.
While there are fair arguments as to why Tesla may be overvalued, a fast-growing business may enable the company to eventually grow into the valuation. And betting on shares to move lower as the business continues to grow by leaps and bounds may continue to be nothing more than a lofty dream for Tesla shorts.
On the flip side, just because a stock isn't a good short doesn't mean it's a good buy. But I definitely wouldn't bet against it.
