Tesla Stock May Have 80% Downside, But Here’s Why It’s Too Risky to Short It

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Tesla (TSLA) has been a high-flyer for years, but the stock has vastly outperformed the actual business, in part because of CEO Elon Musk’s ability to make big promises to investors. But Tesla’s second-quarter earnings report seriously challenged the market’s perception of how fast Musk can launch big projects, such as its robotaxi, and of the strength of its car franchise.

The big question for investors, however, is what they’re getting for their money. Even after its recent decline, the stock’s market capitalization remains around $1.2 trillion.

Often, it’s useful to think about investments in terms of odds: What must go right here, given the stock’s valuation? With a low valuation, a company might simply have to avoid screw-ups for an investment to work well. In contrast, with a high valuation – where investors expect big things like at Tesla – many things have to go right to justify the premium.

Strip away all the hoopla and what would investors demand of a company at Tesla’s valuation? Other companies in the trillion-dollar club might trade at 25 times earnings, implying that Tesla should be earning somewhere near $48 billion annually. It earned just $3.9 billion over the past four quarters, and several of its future projects – robotaxis and the Optimus robot – still require serious development and expense before becoming commercially viable, if they ever can be.

Tesla’s stock plunged in the wake of its second-quarter earnings, as the company had to discount its cars to move them off the lot, seriously denting profitability. Management needed to walk back promises on the rollout of its robotaxi, and the company looks woefully behind rival Waymo, with many seriously doubting whether Tesla’s self-driving car has the right technology for the job.

Then, there’s the Optimus robot, which is slated to begin production later this year. It’s a big, complex task, and as Musk said in Tesla’s most recent earnings call:

It’s one of the hardest things to solve, to make an autonomous humanoid robot that can do tasks that if you simply ask it to do something or show it a video, it can do the task without any programming. No one’s ever achieved this.

So, investors should not be surprised by significant walkbacks on the Optimus rollout timeline either.

As profits fall, Tesla is rapidly ramping up capital expenditures to more than $25 billion this year and is likely to remain at elevated levels for the next two or three years, says management. Even with nearly $45 billion on the balance sheet, however, this level of spending could drain the company’s coffers and may still leave it without “big” viable products.

Given the huge engineering challenges that require stupendous capital spending and the sagging electric car unit, a lot has to go right for Tesla to justify its valuation. Valued against other car companies, Tesla stock could fall 80% from current levels and easily still be considered overvalued, even if you do factor in some positive potential for the company’s moonshot projects.

Given that possible downside, it seems like Tesla should be an obvious candidate for a short-selling trade. The stock already prices in Musk achieving many big things, even as he delivers only promises and cash burn. Still, investors should be extremely cautious about shorting the stock – here’s why.

3 Reasons Tesla Is Too Risky to Short

Despite its lackluster finances, Tesla presents several key risks for investors looking to profit from the stock’s potential decline.

1. Musk’s Bets on Robotaxis and Robots May Pay Off

Despite the long odds on Tesla’s bets on robotaxis and robotics, it’s not out of the question that it may end up with marketable products. If Tesla creates a new product that generates significant revenue, it could provide strong financial support to the stock, especially as the car unit sags.

Plus, if Musk’s attention shifts back from his hidden financial business inside SpaceX (SPCX), a newly refocused Musk could perhaps tighten up the ship at Tesla.

Beyond the risk of Tesla producing actual meaningful products, however, investors who short its stock are also exposed to Musk’s proven ability to jawbone the stock higher on promises of a bigger, brighter future. Investors continue to believe Musk is an engineering wunderkind even after a decade of his promises that autonomous vehicles were coming “next year.”

Sure, Musk could lose his Svengali-like ability to charm the market, but investors actively betting against him may pay a heavy price for underestimating his ability to curate investors’ faith.

2. Tesla’s Stock Price Has Been Irrational for Years

While Tesla’s share price has declined in recent weeks, it sits right around where it was a year ago, following Musk’s ill-advised foray into U.S. politics. Musk’s move turned off many potential car buyers and even already-existing owners, creating a bad reputation around Tesla that arguably resulted in the company’s need to discount cars heavily in this year’s second quarter.

But Tesla’s stock price has been misaligned with the business fundamentals for years, especially since the run-up in the stock amid the COVID-19 financial stimulus. Even in late 2021, Tesla surged past $400 a share, a level that it’s struggled to stay above for a meaningful length of time, even though it spent small parts of the past few years north of that number.

With the stock trading at nosebleed valuations, there’s nothing to keep it from moving higher as Musk mania grips the market. He has been remarkably adept at getting investors to pay up for the stock through a series of big ideas, such as robotaxis, that he says are just around the bend.

So, an irrationally priced stock can always become even more irrationally priced. As the old investing saying goes, “The market can remain irrational longer than you can remain solvent.”

3. SpaceX May Potentially Acquire Tesla

Tesla is also a poor short candidate because there’s a possibility that the Elon Musk-helmed SpaceX could take over the car company. I’ve run through seven reasons why SpaceX might acquire Tesla, but three stand out as particularly important:

• Musk has merged companies before to cover up bad news:Tesla acquired the debt-heavy SolarCity in 2016, which he owned 20% of, helping to bail out his own investment in the renewable energy company, which his cousins ran.

• A SpaceX-Tesla merger puts Musk in full control of Tesla:Musk has full control of SpaceX through supervoting stock, so a purchase of Tesla could mean that he no longer has to deal with shareholders who want to challenge his compensation, for example.

• A SpaceX-Tesla merger strokes Musk’s ego: A merger of the two companies could have a shot at becoming the world’s largest company by market capitalization.

While SpaceX doesn’t have the cash to buy Tesla, it could use its own stock as an acquisition currency, proposing a stock swap. This approach makes it even easier for Musk to overpay for Tesla. If Tesla stock is sagging due to operational reasons, short investors couldn’t be too confident that Musk wouldn’t announce a takeover at a higher price, running Tesla stock up.

For these reasons, although Tesla may look way overvalued, it may still end up being a poor short-selling trade. So, despite its many flaws, Tesla may be a better fit for the “too hard” pile, with most investors likely being better served by looking for investments with higher odds of success.

Regards,

James Royal, PhD

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