One of the best ways to bet against a company you think has fundamental flaws or is overvalued is to short its stock. In the solar industry, short sellers have made a fortune betting against companies over the past decade because one after another has come up short of expectations.
SolarCity (NASDAQ:SCTY) is one of these high expectation stocks, and is one of the most shorted stocks in the industry, with 18 million shares sold short (although a lot of that is covering convertible debt). But this is a risky stock to be selling short, especially considering the fact that Elon Musk is behind the company.
Don't bet against Elon Musk
If there's one man the stock market is irrationally exuberant about it's Elon Musk. His two largest investments in Tesla Motors (NASDAQ:TSLA) and SolarCity have been wild successes on the stock market despite losing money year after year.
With Musk, fundamentals rarely matter -- so if you think SolarCity is going to lose money next year and the year after, it may not matter to the market. If anyone can convince the market he's creating value while losing money it's Musk. Bet against him at your own risk.
Don't bet against growth
If there's one thing that's really hard to bet against, it's growth. A company (Amazon for example) can grow unprofitably for years and investors can bid up shares like crazy. SolarCity will likely be unprofitable through at least next year, but that doesn't mean shares won't rise, because it's growing like crazy.
Growth makes valuing a stock difficult, both on the upside and the downside. I could argue that SolarCity is overvalued based on last year's installation pace of 502 MW, but if they grow to 5 or even 10 times that size in a few years that thesis could be blown out of the water. Betting against growth stocks is a huge risk, and that's exactly what SolarCity is.
Too many unknowns in solar
There are a lot of things that could go wrong for SolarCity in the next few years. The investment tax credit could expire, causing margins and value creation per installation to plunge -- or it could be extended. Homeowners could find buying a house with a lease undesirable, leading to a backlash from current and potential customers -- or customers could pay on time as planned. Competitors could flood the market, pushing installation prices down and squeezing margins for everybody in solar -- or SolarCity could expand its market share lead.
Depending on how the industry unfolds, SolarCity could be a great investment, or shares could plunge. The problem is, no one knows how the solar industry is going to develop in the next few years, or how the public policy environment will treat solar subsidies. Betting against SolarCity is a flip of the coin for any one of these factors.
SolarCity may be a high-risk investment for shareholders, but I think the risks are even higher for short sellers. That's why I wouldn't short the stock today no matter how overvalued you think shares could be.
Travis Hoium has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, SolarCity, and Tesla Motors. The Motley Fool owns shares of Amazon.com, 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.