The Perils of Shorting: A Real Life Example

[joe sod]

the amount of hope and optimism surrounding that company is pretty large, lots of companies make electric cars but TESLA does something special even mechanically they are not that much better , the brand is pretty unique and brand strength is an important component of success

You could have said the same thing about DeLorean, in fact there are a lot of similarities between John Delorean and elon musk. Delorean was a talented car designer , he developed an iconic car loved by the celebrity set and featured in famous movies. But ultimately he did not have the capital to take on the major car manufacturers, he could not mass produce the cars and iron out the glitches.
Didn't elon musk have a run in with the securities and exchange commission over lying to the market about the Saudi wealth fund.

 

[Andrew365]

Yes, they're also profit making.

It is also almost 25 years old.

 

[Andrew365]

You beat me to it. I think if my bank's assets were 100% in Tesla shares I wouldn't be too impressed by the Fed's 30% stress test.

To explain the FRB stress test, it is an instantaneous one day shock calibrated to ~6 month historically the worst moves. Correct me if I am wrong but the entire stock market has not dropped 30% in a day.

 

[Andrew365]

I get the sense of some sour grapes left over from the dot.com bubble here. At least there is only 1% of the portfolio being put at Risk, it is still too much too gamble in my opinion. Bubbles come and go, stocks get overvalued but shorting a stock because you think the share price is overvalued in the same way as Dotcom is just baffling.

A new company trying disrupting an established market is not going to be profitable, but how dare they try....hold on let me get my pitchfork.

Given we talk about sensible investing on this forum, I am still waiting for the evidence relevant to Tesla for the case to short other than anecdotally it "smells funny".

 

[Duke of Marmalade]

To explain the FRB stress test, it is an instantaneous one day shock calibrated to ~6 month historically the worst moves. Correct me if I am wrong but the entire stock market has not dropped 30% in a day.

Watch my lips. I wasn't talking about the whole sm, I was talking about Tesla.

 

[Sunny]

No offence Andrew but you brought up FED stress tests when they are not relevant when talking about a single stock. I come from a era in banking where quants ruled the world. I analysed and bought and sold CDO's, CDO squared and even to my shame, one CDO cubed. I have seen rating models that told me Iceland was a AAA rating while CDS spreads were at 600bps. I have seen AAA ABS portfolios with default probability of close to 0% default. I have seen VAR models tell me that the most I can lose in 1 day with a 99% confidence level was 500k which was laughable when black swan event that the model said couldn't really happen in the real world happened. I have heard bankers tell me that the repo market for bank bonds will always be there until it wasnt. I was told recovery rates on senior bonds of 40% that fed into all models was sensible when very rarely did I see a recovery rate of anything approaching 40%. I was told Government Bonds were as good as cash until they weren't.

So if you are asking me if I think a share price of am individual share can fall over 60% when it has risen by over 60% in six months is possible then 100% yes. And I dont care what a model tells me. Especially on an event and news driven stock with a historic implied volatility of 40-60%.

Doesn't mean I would short it but it certainly doesn't mean I would invest either. If you are so confident about companies like uber and Tesla, then you can fill your boots on the long side and wave at Brendan and Colm. Joy's of the market.

 

[Sunny]

By the way, I dont have recent figures but at one stage last year, the CDS market was pricing a default by Telsa at about 40% in the next 5 years. And yet the equity market has seen its share price rise by over 60% in six months on the back of nothing but generating some free cash flow and increased sales. Telsa still hasn't proved it will have the ability to meet any large increase in demand through their current production lines so. China could just as easily close them down over there as quickly as they let them in. Musk is the Donald trump of business so who knows what that brings. There are numerous other reasons I dont believe in Telsa and that's without even following the stock but Colm has done great analysis before this thread went off topic.

 

[Andrew365]

No offence Andrew but you brought up FED stress tests when they are not relevant when talking about a single stock. I come from a era in banking where quants ruled the world. I analysed and bought and sold CDO's, CDO squared and even to my shame, one CDO cubed. I have seen rating models that told me Iceland was a AAA rating while CDS spreads were at 600bps. I have seen AAA ABS portfolios with default probability of close to 0% default. I have seen VAR models tell me that the most I can lose in 1 day with a 99% confidence level was 500k which was laughable when black swan event that the model said couldn't really happen in the real world happened. I have heard bankers tell me that the repo market for bank bonds will always be there until it wasnt. I was told recovery rates on senior bonds of 40% that fed into all models was sensible when very rarely did I see a recovery rate of anything approaching 40%. I was told Government Bonds were as good as cash until they weren't.

So if you are asking me if I think a share price of am individual share can fall over 60% when it has risen by over 60% in six months is possible then 100% yes. And I dont care what a model tells me. Especially on an event and news driven stock with a historic implied volatility of 40-60%.

Doesn't mean I would short it but it certainly doesn't mean I would invest either. If you are so confident about companies like uber and Tesla, then you can fill your boots on the long side and wave at Brendan and Colm. Joy's of the market.

Sunny, I do not disagree with what you are saying and the CDS spread is the best piece of information posted here for the case of shorting Tesla. I have never come across a short without a time limit, it just is not logical to me from an investment perspective.

I brought the FED Stress Tests up as Tesla is part of the Market and I was trying to tease out the rationale for setting the exit point at $200 and over what time frame, which as you point out is larger than the historical implied volatility of Tesla. As I pointed out the entire US Market has increased ~30% in the last year with Tesla outperforming. Do you not agree that a large fall to the magnitude of 67% happens either as a complete idiosyncratic standalone event in Tesla or a combination of the market decreasing and Tesla decreasing more than the market?

If it is the latter and Brendan has other long exposure the US Equity market then more than 1% of his portfolio is at risk. I was just hoping for some more rationale and reason for the short other than speculation.

For now, I have accepted this short as a Gamble, I don't like shorts, it infers that you want the company to fail. I guess I am just an optimist looking for companies that are trying to make a difference succeed.

 

[Gordon Gekko]

I do not believe that any of us have the experience or depth of knowledge to opine on Tesla’s future prospects. That is why my Tesla position is via the investment manager, Baillie Gifford. They were early supporters of Amazon and Netflix, and have a good track record in this space.

I read a summary of their investment case for Tesla and I like what I read:

- Electric vehicles are better than their internal combustion counterparts. They are faster, safer, and can absorb new technology. The view is that if the price point is the same for an equivalent unit, the EV wins. This has been achieved in the US with the Model 3 vs the BMW 3 Series, hence the 400,000 Tesla units sold last year.

- The Chinese deal is transformational. Without having to go in via a joint venture, they’re now manufacturing in the world’s biggest car market without tariffs. Brand building and winning the Chinese consumer around fundamental Chinese issues such as air quality would be transformational.

- It is not an automotive business in the traditional sense so people need to stop viewing it that way; it’s a software business. Tesla vehicles will get better as they age in terms of user experience, unlike ‘normal’ vehicles which decline in quality.

- The internationalisation of production will be a huge driver of growth as costs go down and quality goes up. They were manufacturing in Silicon Valley!

- The Model Y SUV will be transformational; SUVs command a price premium but cost the same to build!

- There have been self-inflicted blows to the balance sheet but they’re done; this is now a business with strong cashflows and profitability on the horizon.

- Baillie Gifford saw their large holding in Amazon fall by 1/3 in 2006 and then 1/2 in 2008; it happens with such businesses. They firmly believe in Tesla.

And I believe in Baillie Gifford; they know a damn sight more about picking growth ‘winners’ than any of us.

 

[Sunny]

This thread is actually a good example of the psychology of investing and the inherent bias we have. If I came on here and offered an investment opportunity with a fund manager who would actively manage your investment but had a brilliant track record with picking growth stocks and were early investors of Amazon and netflix, I bet the majority of people would say a monkey would have as good a chance of picking growth stocks that will outperform.

I dont doubt the skill of Baille Gifford but I bet you that you actually like the idea of Tesla yourself even without realising it and this just re-enforces it. I could show you research that raises doubt about the China market and raises questions about growth without significant money raising. But it probably wouldn't make any difference. We all seem have our views and I dont think we are going to change each others minds.

Meanwhile Brendan will probably start selling ad space on AAM to pay for increasing margin calls.........

 

[Brendan Burgess]

Meanwhile Brendan will probably start selling ad space on AAM to pay for increasing margin calls.........

I would love to have the tech skills to put up a spoof ad for Tesla

 

[Gordon Gekko]

This thread is actually a good example of the psychology of investing and the inherent bias we have. If I came on here and offered an investment opportunity with a fund manager who would actively manage your investment but had a brilliant track record with picking growth stocks and were early investors of Amazon and netflix, I bet the majority of people would say a monkey would have as good a chance of picking growth stocks that will outperform.

I dont doubt the skill of Baille Gifford but I bet you that you actually like the idea of Tesla yourself even without realising it and this just re-enforces it. I could show you research that raises doubt about the China market and raises questions about growth without significant money raising. But it probably wouldn't make any difference. We all seem have our views and I dont think we are going to change each others minds.

Meanwhile Brendan will probably start selling ad space on AAM to pay for increasing margin calls.........

Not quite, but you are on to something.

I want Tesla to succeed. I want companies like Tesla to succeed. I want Elon Musk to succeed. The world needs people like him.

But I do put my faith in Baillie Gifford who identified companies like Amazon and Netflix early on.

 

[Andrew365]

Not quite, but you are on to something.

I want Tesla to succeed. I want companies like Tesla to succeed. I want Elon Musk to succeed. The world needs people like him.

But I do put my faith in Baillie Gifford who identified companies like Amazon and Netflix early on.

The world does need people like him! There was a comparison to the Delorean earlier but as far as I am aware the Delorean design didn't change the way car doors open. Tesla pioneered EV's and every car manufacturer has moved faster towards EV in response, ultimately the forward-thinking of Tesla could be its downfall. Interestingly Musk is the longest-tenured CEO of a Car Company globally, whether that is good or bad. We should take a step back and appreciate his success.

 

[Duke of Marmalade]

To explain the FRB stress test, it is an instantaneous one day shock calibrated to ~6 month historically the worst moves. Correct me if I am wrong but the entire stock market has not dropped 30% in a day.

It is an instantaneous shock, that is happening in an instant. The stock market never has and probably never will fall instantaneously by 30%. It is a theoretical construct and is used as a proxy for a 6 month shock, as it would take 6 months to adjust to the shock.

 

[Gordon Gekko]

I get the sense that some people think Tesla is a niche player in the market; they’re outselling Mercedes and BMW in the US!

We cannot just look at profitability alone when we’ve seen businesses grow their customer/user base and then pivot into massive profitability.

 

[Sunny]

Here is an interesting piece. No idea if he is right or wrong but anyway I dont think it really matters at this stage. People either believe or they dont.

Expect Flat Unit Sales For Tesla In 2020

While Tesla’s unit sales rose 4-5% in the U. S. overall in 2019, they actually fell—my modeling shows a decline of 4-5%—in the fourth quarter.

www.forbes.com

 

[Brendan Burgess]

We should take a step back and appreciate his success.

Let's be absolutely clear. I think he is a very talented guy and has built a great car and I wish him well.

But that does not make his company worth €86 billion.

Likewise I love using Uber and I wish we had it in Dublin, but it's hard to see how it can make any profit, much less a profit to justify its current valuation.

I hate tobacco companies, but they are very profitable.

Brendan

 

[NoRegretsCoyote]

Likewise I love using Uber and I wish we had it in Dublin, but it's hard to see how it can make any profit

Taxi dispatch operators were profitable business for decades, and Uber is just doing the same thing a lot more efficiently.

Why do you think it can't increase its margins once it has the market share and an established user base?

At the moment it loses $1 a ride, which is not astronomical.

 

[Andrew365]

It is an instantaneous shock, that is happening in an instant. The stock market never has and probably never will fall instantaneously by 30%. It is a theoretical construct and is used as a proxy for a 6 month shock, as it would take 6 months to adjust to the shock.

Correct, the point is to test the strength of the business if such a shock were to happen, and a way to make banks hold more capitals. Since the Financial Crisis, a lot of banks have now stopped the complex products they offer and are a large portion of the business is vanilla. These products are generally well hedged to within x of the market, and given the low markey volatility in the last few years it needs this shock. If 30% actually happened in one day, we would most likely have bigger worries than the value of our Equity portfolios.

 

[Andrew365]

Let's be absolutely clear. I think he is a very talented guy and has built a great car and I wish him well.

But that does not make his company worth €86 billion.

Likewise I love using Uber and I wish we had it in Dublin, but it's hard to see how it can make any profit, much less a profit to justify its current valuation.

I hate tobacco companies, but they are very profitable.

Brendan

Brendan,

I would still love to hear, you rational for setting at $200, was it simply because it traded at that last year? Here is what appears a slightly bullish way to value but none the less it brings up some valid points. Note, I don't know if it is worth $86bln but given I am not investing in it I don't need to, I would expect that you could rationalize your investment. Even if you have only risked 1%, why risk any of it without proper due diligence?

"Regarding the bears, it’s amusing to see how many people insist on analyzing Tesla through old-school methods of valuation. It’s like they’ve already forgotten how Amazon.com Inc. AMZN, -0.40% raced up from $50 a share in 2008 to $500 a share in 2015 despite a lack of earnings per share."

"In the bullish camp, it’s equally ridiculous to see people get worked up when discussing how awesome Tesla’s cars are, how cool Tesla CEO Elon Musk is and how in 10 years this company will have single-handedly transformed the global economy — and heck, maybe started an economy on the moon, too. It’s all well and good to be an optimist, but any decent investor knows that getting emotional about a particular product or stock is a surefire way to make mistakes with your money. "

Here’s how to rationally value Tesla’s stock

Drop the irrational and extreme bull and bear calls on the share price.

www.marketwatch.com