3 Bear Arguments Tesla Bulls Can’t Ignore

Sam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Tesla (NASDAQ: TSLA) might just be the hottest stock out there, and for good reason. Shares are up a staggering 117% in just the last two months.

But is it too late to get in? Have investors missed the boat? Anyone interested in buying shares at these levels must consider the following:

1) Tesla’s current share price is largely due to a short squeeze

Tesla shares likely wouldn't be where they are today if the stock had not been so heavily shorted in the past. Before the recent explosion to the upside, roughly 45% of floating shares had been bet against.

Since mid April, short interest has plunged, dropping from about 30.6 million to less than 20 million shares. Granted, the short interest is still relatively high -- about 25% -- so the squeeze may continue for some time.

But the important thing to realize is that the buying that has taken Tesla shares from about $50 to near $120 has been largely artificial. Rather than new investors coming in to take advantage of an attractive company, bearish investors have buying shares to limit their losses.

The problem for Tesla shareholders is that short squeezes often end in a sharp correction to the downside. Once all the bears have covered, there are no buyers left to keep the price elevated, and so shares plunge.

BlackBerry’s short squeeze comes to an end

A recent example of this phenomenon is BlackBerry (NASDAQ: BBRY). Shares appreciated about 170% from Sept. 2012 to Jan. 2013 ahead of the official unveiling of BlackBerry’s newest operating system, BB10.

Most of the buying that sent BlackBerry shares surging was likely done by shorts covering their positions, afraid of BB10’s potential to reinvent the Canadian handset maker. BlackBerry short interest fell about 40% from Oct. 2012 to Jan. 2013.

But that short covering ended with a bang last week, when BlackBerry shares lost about a third of their value after a disappointing earnings report. BB10 appears to be a failure, and shorts have little reason to fear losing their shirts.

A similar fate could befall Tesla. If the company runs into any problems at all -- disappointing earnings, regulatory issues, whatever -- the short squeeze could quickly reverse itself, and Tesla shares could plummet.

2) Mass market electric cars are still facing many barriers

While a post-short squeeze correction might be Tesla’s biggest problem in the short-term, the company still faces significant long-term challenges as well.

Tesla has shown that it can successfully sell a high-end luxury car to the high-end market. But can it actually sell mass market vehicles? Significant barriers to mainstream electric adoption remain.

Primary barriers include price and range anxiety. If one excludes trucks (a major segment of the auto market that seems particularly ill-suited to electrification) all of May’s top selling vehicles started for under $30,000 -- some, like the Honda Civic, start under $20,000.

If Tesla’s going to justify its $13.6 billion market cap (about 28% of General Motor’s (NYSE: GM)) it’s going to have to make mass market cars eventually.

The Leaf is an affordable, fully electric car (starting at just over $20,000) but Nissan sold only around 7,000 Leafs in May. Perhaps that’s because the car gets only about 75 miles per charge.

Tesla has plans for a fast-charging network and battery swap stations. That would go a long way towards curing Americans of any range anxiety that they might have, but Tesla still has to execute, and it will be interesting to see how long it takes them to cover the country (if they ever do).

3) Tesla’s valuation is absurd

Lastly, Tesla is just about the furthest thing possible from a value stock. It has no official price-to-earnings ratio (it only recently became a profitable company last quarter) let alone a dividend. Even based on analyst projections, Tesla’s forward PE ratio of 137 is roughly 14 times GM’s.

Perhaps GM is undervalued -- the king of value investing, Warren Buffett himself, owns 25 million shares, roughly 1% of Berkshire Hathaway’s portfolio. And it's an investment that's paid off.

While GM’s run hasn't been as impressive as Tesla’s, it is up about 70% from around the time Berkshire bought shares. Hedge fund manager David Einhorn has also been bullish on GM, arguing last October that it was undervalued largely due to investors’ inability to forget the past.

GM’s stock is more boring than Tesla’s, but if investors are looking to play autos, perhaps following Buffett and Einhorn into GM is a better idea than betting on an excessively valued Tesla.

Investing in Tesla

If you're looking at Tesla as a very long-term, speculative investment, then these factors are probably not that important. Certainly, Tesla presents the possibility of a revolutionary growth company -- the other auto stocks, not so much.

But investors jumping into Tesla now should be aware that the stock could be in for a correction at some point in the near future. Stocks that rally rapidly based on short squeezes oftentimes have an equally impressive collapse.

Moreover, Tesla still has to overcome some significant challenges. Ultimately, it must produce a mass market car that people want to buy if it is to justify its current valuation.

Despite the long-term opportunity that exists with Tesla, the big automakers are faced with a vast opportunity themselves. And it's set to grow even bigger in coming years. A recent Motley Fool report, "2 Automakers to Buy for a Surging Chinese Market", names two global giants poised to reap big gains that could drive big rewards for investors. You can read this report right now for free – just click here for instant access.

Sam Mattera is long Tesla puts dated September. The Motley Fool recommends General Motors and Tesla Motors . The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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