Tag Archives: Tesla

Quick Take: The Great “Tesla” Hysteria Of 2020

“Let us see how high we can fly before the sun melts the wax in our wings.” – E. O. Wilson

Since January 1, 2020, Tesla’s (TSLA) stock price has risen by $462 or 110%. TSLA’s market cap now exceeds every automaker except for Toyota. In fact, it exceeds not only the combined value of the “big three” automakers GM, Ford, and Chrysler/Fiat, but also companies like Charles Schwab, Target, Deere, Eli Lily, and Marriot to name a few large companies.

Seem crazy? Not as crazy as what comes next. Crazy are the expectations of Catherine Wood of ARK Invest. This well-known “disruptive innovation” based investor put out the following chart showing an expected price of $7,000 in 2024 with a $15,000 upside target.

Siren songs such as the one shown above encourage investors to chase the stock higher with reckless abandon, and maybe that is ARK’s intent. Given their large holding of TSLA, it certainly makes more sense than their price targets. Instead of taking her recommendations with blind faith, here are some statistics to illustrate what is required for TSLA to reach such lofty goals.

To start, let’s compare TSLA to their peer group, the auto industry. The chart below shows that TSLA has the second largest market cap in the auto industry, only behind Toyota. Despite the market cap, its sales are the lowest in the industry and by a lot. According to figures published on their website, TSLA sold 367,500 cars in 2019. General Motors sold 2.9 million and Ford sold 2.4 million.

Clearly investors are betting on the future, so let’s put ARK’s forecast into context.  

If the TSLA share price were to rise to their baseline forecast of 7,000, the market cap would increase to $1.26 trillion. Currently, the auto industry, as shown above, and including TSLA, aggregates to $772 billion. At the upside scenario of 15,000, the market cap of TSLA ($2.7 trillion) would be almost four times the current market cap of the entire auto industry.  More stunning, it would be greater than the combined value of Apple and Microsoft.

Even if we make the ridiculous assumption that TSLA will be the world’s only automaker, a price of 15,000 still implies a valuation that is three to four times the current industry average based on price to sales and price to earnings. At 7,000, its valuation would be 1.6 times the industry average. Again, and we stress, that is if TSLA is the world’s only automaker.

Summary

Tesla is one of a few poster children for the latest surge in the current bull market. That said, it’s worth remembering some examples from the past. For instance, Qualcomm (QCOM) was a poster child for the tech boom in the late 1990s. Below is a chart comparing the final surge in QCOM (Q4 1999) to the last three months of trading for TSLA.

In the last quarter of 1999, QCOM’s price rose by 277%. TSLA is only up 181% in the last three months and may catch up to QCOM’s meteoric rise. However, if history is any guide, QCOM likely offers what a textbook example of a blow-off top is. By 2003 QCOM lost 90% of its value and would not recapture the 1999 highs for 15 years. 

Tesla may be the next great automaker and, in doing so, own a sizeable portion of market share. However, to have estimates as high as those proposed by ARK, they must be the only automaker and assume fantastic growth in the number of cars bought worldwide. Given their technology is replicable and given the enormous incentives for competitors, we not only find ARK’s wild forecast exceedingly optimistic, but we believe it is already trading near a best-case scenario level.

One final factor that ARK Invest also seems to have neglected is the risk of an economic downturn. Although they do highlight a “Bear Case” price target of $1,500, that too seems incoherent. Given that TSLA is still losing money and is also heavily indebted, an economic slowdown would raise the risk of their demise. In such an instance, TSLA would probably become the property of one of the major car companies for less than $50 per share.

TSLA’s stock may run higher. Its price is now a function of all the key speculative ingredients – momentum, greed, FOMO, and of course, short covering. The sky always seems to be the limit in the short run, but as Icarus found out, be careful aiming for the sun.

**As we published the article Tesla was up 20% on the day. The one day jump raised their market cap by an amount greater than the respective market caps of KIA, Hyundai, Nissan, and Fiat/Chrysler!!

Should Tesla Bears Look To Hibernate

In May 2019, I published an article that outlined hope for TSLA bulls in which I suggested that $180 could provide an opportunity for a long position.  Since then, Tesla (TSLA) has established and strengthened along a new uptrend line.  There is now evidence of key resistance near the $260 and $280 levels.  The technical levels below show the key resistance trend lines, based upon weekly highs and lows since 2017. 

The prior five weeks saw TSLA trade in a narrowing technical triangle, and last week’s breakout, followed by this week’s strength, appears to be a breakout through the first level of technical resistance.  The current uptrend line is gaining strength and momentum.  If the price closes convincingly above $280 on a weekly basis, the Tesla bears may want to hibernate for the winter.  

Fundamentals and Markets

When it comes to valuing stocks and commodities, I call myself a “recovering fundamentalist.”  Having spent much of my career building private businesses, I am used to focusing primarily on EBITDA, discounted cash flows, and other fundamental metrics when evaluating stocks.  When it comes to TSLA, I tend to agree with the bears that TSLA’s share price is not justified by fundamentals.  In fact, TSLA’s market cap could be used as exhibit #1 to support the thesis that stocks are not valued upon fundamentals at all.

In the short run, stock and commodity prices are driven by human emotions (fear and greed) and subsequent money flows.  Fundamentals – positive or negative – can provide the narrative and longer-term trends by which investors become bullish or bearish.  I certainly don’t want to dissuade anyone from assessing TSLA weekly auto-deliveries or to research its accounting statements.  Nevertheless, this recommendation is based solely on my technical view of the current price action, regardless of Tesla’s bearish fundamental backdrop.   

The TSLA Options Market

The options market provides institutions and other large position holders an ability to hedge their TSLA exposure, whether the funds are invested long or short.  Since TSLA has a history of being difficult or expensive to short, the options market provides an outlet for those negative on the stock price. Due to the high demand, TSLA options tend to be liquid with high open interest.  There are many retail and institutional investors who short TSLA by buying puts.

The market makers who facilitate the options trading almost always hedge their exposure instantaneously and dynamically with delta-neutral strategies. 

What this means is the market makers perform combination trades to (theoretically) hedge their exposure to price while also profiting from options volatility.  The maximum profit for the market makers will occur if the price of the stock settles near the price level where their portfolio is delta neutral.  As a result, it can be instructive to track delta- and gamma-neutral levels in many different stocks, ETFs and commodities. For more on delta and gamma signals, you can download a quick presentation from this link.

Stock Price and Options Sentiment

Due to order flow, contract rollover, and hedging dynamics, there tends to be a convergence between stock prices and the point of delta- and gamma-neutral as option expiration comes nearer.  We can provide evidence for this convergence for many different stock indices, ETFs and commodities.  The chart below is TSLA stock price versus Delta Neutral and Gamma Neutral for the last several months.   Of particular note is the convergence between price (green) and Delta (red) and Gamma (blue) Neutral for each option expiry period (black square).

Not surprisingly, as TSLA broke through technical resistance last week, its Delta- and Gamma-Neutral levels followed price upward.  Our interpretation of this data is that the option market makers are also buying into the upward momentum.  Beyond the option expiration this coming Friday, additional data for November and December suggest that the options market will not necessarily be a headwind for continued advances in price.

The table below shows bullish put-call ratios and Gamma Neutral levels above $280 for the coming months.

Source: Viking Analytics

The basic theory behind the Delta Neutral and Gamma Neutral levels can be found by visiting our website www.viking-analytics.com.

Final Thoughts

Based upon the technical analysis and the Delta Neutral and Gamma Neutral levels, a long position in TSLA should be considered, preferably on a retest of $240. We would also advise limiting risk with a stop loss rule that would exit the trade on a weekly close below the key trend line.

This is for informational purposes only and is not trading advice.

Can Tesla Hold The Line?

Tesla bulls and Elon Musk fans everywhere are hoping that the decline in Tesla stock price will end soon.  After the stock breached the technically important $250 price level, the next key support level is in the $180 range, close to where the stock is trading now. 

Tesla has emotionally attached both bullish and bearish investors. Spend ten minutes on financial Twitter and the emotions from those thinking Tesla is going to zero to those thinking the right price in the 1,000’s is easily evident. Bulls certainly want Tesla to hold the $180 line, but as Toto sang in the 1970s, “Love isn’t always on time.” 

On a weekly chart, we can see that the $180 price level has served as important support and resistance since 2013.  More evidence supporting the Tesla is oversold, is that weekly RSI is as over-sold as the most recent dip below $180 in early 2016.

A linear regression of the recent TSLA downtrend on a daily chart shows price currently extended at the bottom of the range.  This linear regression has a high confidence factor over 92%.

The TSLA Options Market

The options market provides institutions and other large position holders an ability to hedge their TSLA exposure, whether the funds are invested long or short.  Since TSLA has a history of being difficult or expensive to short, liquidity is abundant in TSLA options.  I imagine that there are many retail and institutional investors who short TSLA by buying puts.

The market makers who facilitate this trade almost always hedge their exposure instantaneously and dynamically with delta-neutral portfolios.  The market makers perform combination trades to (theoretically) hedge their exposure to price while also profiting from options volatility.  The maximum profit for the market makers will occur if the price of the stock settles near the price level where their individual portfolio is delta neutral.  As a result, it can be enlightening to track neutral delta levels for Tesla as we do for many different stocks, ETFs and commodities.

TSLA Op-ex Sweet Spot

I consider the price range between Neutral Delta and Neutral Gamma to be the “sweet spot” for stock prices on or before option expiration.  On May 29th, TSLA had a sweet spot in the $207 to $225 range for the June 21st op-ex.  As such, our indicator currently considers TSLA to be over-sold near $180/share. 

Source: Viking Analytics

Additional Comments

  1. Put-call ratios in the 1.2 to 2.4 range suggest that there is potential support for TSLA in the event of a sharp decline in price.  TSLA’s put-call ratios have fallen somewhat over the past week, however. 
  2. At the closing price of $188 on May 30th, the total value of at-the-money puts in TSLA stock was $1.25 Billion greater than the total value of at-the-money calls for the next three option expirations.
  3. The basic theory behind the Neutral Delta and Neutral Gamma levels can be found by reading a quick introduction on this link: Introduction to Options Sentiment.

Price and Neutral Delta Converge

Due to order flow, contract rollover and hedge dynamics, there tends to be a convergence between stock prices and the point of delta neutral as option expiration comes nearer.  Here is TSLA stock price versus Neutral Delta and Neutral Gamma for the month of May 2019 into the June option expiration.

Gamma is a Wild Card

Extreme divergences between Neutral Gamma and price can also point towards forced-buying or forced-selling events.  I have outlined this dynamic in several articles, including: Negative Gamma and the Demise of Optionsellers.com.   Neutral Gamma is currently trending with price, which is common.  However, our data shows that Neutral Gamma may begin to spike as option expiration comes nearer.  This highlights the potential for forced selling by the put sellers as option expiration comes nearer.   

Final Thoughts

Tesla is over-sold on several metrics.  The weekly RSI is at a multi-year low, and price is currently at the bottom of an orderly downtrend channel.  The options market has priced in a modest recovery into June option expiration; however, there is potential for a forced selling event if too many puts remain in the money.  I will consider a long trade in TSLA in early to mid-June if it successfully tests the $180 price level and the forced selling potential dissipates.

Disclaimer

This is for informational purposes only and is not trading advice.

Why Tesla At $10 Is Not Far-Fetched

Last week, Morgan Stanley analyst Adam Jonas shocked the investing world by cutting his worst-case forecast for Tesla stock from $97 to just $10 per share (it was trading at approximately $200 per share at the time of the announcement). Jonas cited the company’s heavy debt load and exposure to China as the main reasons for his downgraded outlook

“The reduction in our bear case to $10 is driven primarily by our concerns around Chinese demand for Tesla products.”

“Our revised bear case assumes Tesla misses our current Chinese volume forecast by roughly half to account for the highly volatile trade situation in the region, particularly around areas of technology, which we believe run a high and increasing risk of government/regulatory attention.”

Tesla’s stock price has plunged by over 50% or $200 since its peak in December:

(We actually recommended a short position in Tesla back in April in our RIA PRO premium subscription service. Click here to try this service free for 30 days.)

While most analysts and financial journalists completely laughed off Adam Jonas’ $10 worst-case forecast for Tesla stock, what immediately came to my mind was that it was not far-fetched at all. While Jonas’ basis for that price was the company’s heavy debt load and exposure to China, which are both valid risks in their own right, I have been warning about a much larger macro risk that virtually nobody else is discussing: Tesla’s exposure to the U.S. household wealth bubble. I discussed this risk in November in a piece called “Here Are The Hidden Risks That Will Sink Tesla” and I still hold the same view now.

To summarize my argument, U.S. household wealth has been experiencing a bubble in recent years because the Fed has artificially inflated stock and bond prices. This household wealth bubble has created a wealth effect that has helped to temporarily boost consumer spending, including sales of Tesla automobiles. Tesla is a luxury car company that sells expensive cars to affluent people, and the U.S. is responsible for approximately half of Tesla’s sales. As much as Tesla has been struggling (Tesla lost nearly $1 billion in 2018 and $2 billion in 2017), those struggles are occurring during the largest wealth bubble that has ever occurred in America’s history. If Tesla can’t make it in this frothy environment, they’re not going to make it period. Unfortunately, like all bubbles, today’s household wealth bubble will violently burst, just like it did in the early-2000s and in 2008 and 2009. When that happens, Tesla will bleed red ink like never before and $10 per share may become a reality.

You Can’t Get Blood Out Of A Stone

My title comes from Jeremy Grantham’s recent CNBC interview. This remark occurs in a discussion about likely returns from the U.S. stock market. Everyone at Grantham’s firm, Grantham, Mayo, van Otterloo (GMO), agrees that over the next two decades stocks will deliver around 2% after-inflation or “real” returns, says Grantham himself. Traditionally, the market has delivered 6%-7% annualized real returns, but trying to achieve that now will be like trying to draw blood out of a stone. Investors hoping for the historical 6%-7% are bound to be disappointed.

The reason for Grantham’s pessimism is simple — P/E ratios are high. Grantham uses the Shiller PE (current price of the S&P 500 Index relative to the underlying constituents’ past 10-year average real earnings). The long term average of that metric is around 16, but over the past quarter century is has been over 20. But Grantham doesn’t think the average will return to 16 soon or in a way that value investors want. It will likely take around two decades instead of a more typical 7-year cycle. And, in a way, that’s more painful than having a market crash. A crash amounts to a valuation re-set; prices get cheap, and the opportunity to invest presents itself to those with courage. But a slow movement from a Shiller PE of 30 (where it sits now) to 16 is a real problem for long term investors who won’t get a good opportunity for returns for a generation.

Besides expensive valuations, the economic cycle will not be in investors’ favor. Grantham thinks recent growth numbers reflect a one-time bump of sidelined workers getting back into the labor market from the time of the financial crisis. That increase has produced an aritificial percentage point of growth in recent years, Grantham estimates, which means the U.S. isn’t growing at, say, 2.5%. Instead it’s growing at more like 1.5%. That will be apparent, in Grantham’s opinion, as the last workers who were frightened out the labor market after the crisis re-enter. Perhaps that game of re-entry can persist for a few more years, Grantham speculates, but it’s not a permanent feature of the economy. When it ceases, growth will suffer.

Moreover, population growth in the U.S. is declining. We need a 2.1 fertility rate to keep growing, and the U.S. has a 1.76 fertility rate. Also, the fertility rate is below that in every other developed country. The population growth rate in the developed world “has gone to hell,” says Grantham. Only emerging markets countries present the prospect of stronger population growth. Besides a growing population in emerging markets, Grantham is also impressed with China’s emphasis on engineering and science education. China is beginning to dominate Artificial Intelligence and green energy, for example. India isn’t far behind, and, when pressed to single out a country that might be the single best investment in the emerging markets space, Grantham singled out India. Even if Grantham is uncomfortable making a specific country call, all of this means he thinks emerging markets are the future for equity investors. It’s a given, however, that emerging markets investors will have to endure volatility.

Grantham is less keen on Europe. Population growth is worse there than in the U.S., and the recent problems with immigration will only worsen, stressing the EU considerably. And a weakened EU grants more opportunity to China and Russia to misbehave. It also increases uncertainty. Brexit looks like it might be delayed, and when it’s delayed it looks like the odds of overturning it might increase somewhat. Still, Grantham provides no guarantees regarding the country of his birth.

While population growth — or lack thereof — present problems for the economy, at least it’s beneficial for the planet. Grantham has devoted time and resources to combat global warming and harm to the environment. Grantham proudly drives a Tesla, but noted that, as a value investor, he wasn’t interested in the company’s stock. He did allow that the stock could be successful, as Amazon’s has been.

The message investors should take from Grantham’s remarks is that stock returns in the developed world will be low for the next decade and possibly longer. That means you must increase your savings rate to meet your retirement and other goals. The market probably won’t do the heavy lifting that it’s done in the past.

Tesla Plunges 13%; Musk: ‘Our Products Are Still Too Expensive’

Tesla stock plunged nearly 13% today on news that the company will lay off about 3,000 employees or 7% of its total staff as speculation mounts that demand for its Model 3 sedan is falling.

Here’s an excerpt of the email Tesla Chief Executive Elon Musk sent to employees:

As we all experienced first-hand, last year was the most challenging in Tesla’s history. However, thanks to your efforts, 2018 was also the most successful year in Tesla’s history: we delivered almost as many cars as we did in all of 2017 in the last quarter alone and nearly as many cars last year as we did in all the prior years of Tesla’s existence combined! Model 3 also became the best-selling premium vehicle of 2018 in the US. This is truly remarkable and something that few thought possible just a short time ago.

Looking ahead at our mission of accelerating the advent of sustainable transport and energy, which is important for all life on Earth, we face an extremely difficult challenge: making our cars, batteries and solar products cost-competitive with fossil fuels. While we have made great progress, our products are still too expensive for most people. Tesla has only been producing cars for about a decade and we’re up against massive, entrenched competitors. The net effect is that Tesla must work much harder than other manufacturers to survive while building affordable, sustainable products.

Today’s unfortunate news confirms a warning I made in early-November in a piece called “Here Are The Hidden Risks That Will Sink Tesla“:

Elon Musk’s Tesla has been struggling financially since its inception and has lost over $1.1 billion in 2018 alone despite a surprise profit in the third quarter. As much as Tesla has been struggling, I just wanted to point out that Tesla’s struggles are occurring during the largest wealth bubble that has ever occurred in America’s history. Tesla is a luxury car company that sells expensive cars to affluent people, the U.S. is responsible for approximately half of Tesla’s sales, and U.S. wealth is artificially inflated and heading for a bust. Simply put, America’s wealth bubble is enabling many more people to buy Tesla automobiles than would ordinarily occur in a non-bubble environment.

As I explained in a recent presentation, U.S. household wealth has surged by approximately $46 trillion or 83% since 2009 to an all-time high of $100.8 trillion. Since 1951, household wealth has averaged 379% of the GDP, while the Dot-com bubble peaked at 429%, the housing bubble topped out at 473%, and the current bubble has inflated household wealth to a record 505% of GDP (see the chart below):

If Tesla can’t make it in this frothy environment, just imagine what will happen when America’s wealth bubble truly bursts and consumers are forced to dramatically tighten their belts…

Please follow me on LinkedIn and Twitter to keep up with my updates.

Please click here to sign up for our free weekly newsletter to learn how to navigate the investment world in these risky times.

Here Are The Hidden Risks That Will Sink Tesla

Elon Musk’s Tesla has been struggling financially since its inception and has lost over $1.1 billion in 2018 alone despite a surprise profit in the third quarter. As much as Tesla has been struggling, I just wanted to point out that Tesla’s struggles are occurring during the largest wealth bubble that has ever occurred in America’s history. Tesla is a luxury car company that sells expensive cars to affluent people, the U.S. is responsible for approximately half of Tesla’s sales, and U.S. wealth is artificially inflated and heading for a bust. Simply put, America’s wealth bubble is enabling many more people to buy Tesla automobiles than would ordinarily occur in a non-bubble environment.

As I explained in a recent presentation, U.S. household wealth has surged by approximately $46 trillion or 83% since 2009 to an all-time high of $100.8 trillion. Since 1951, household wealth has averaged 379% of the GDP, while the Dot-com bubble peaked at 429%, the housing bubble topped out at 473%, and the current bubble has inflated household wealth to a record 505% of GDP (see the chart below):

Net Worth As Percent Of GDP

Please watch my presentation “Why U.S. Wealth Is In A Bubble” to learn more:

China accounts for 16% of Tesla’s sales and is the largest market for Tesla automobiles after the United States. China is experiencing a massive credit bubble in which total debt-to-GDP nearly doubled in the past decade from just over 150% to 300%. Debt booms like the one China is currently experiencing help to supercharge the economy in the short run and create scores of new Tesla-buying millionaires and billionaires, but are ultimately doomed as they simply borrow growth from the future. China in the past decade is following a similar trajectory to Japan in the 1980s before its bubble burst (and is still struggling with deflation three decades later).

China's Debt Bubble

Norway accounted for 8.2% of Tesla’s sales last year and is the third largest market for Tesla automobiles. Norway is currently experiencing a housing bubble in which housing prices have approximately tripled since 2005. As the U.S experienced in the mid-2000s, housing bubbles create a wealth effect that encourages consumer spending (and splurging on luxuries like Tesla cars).

To summarize, at least three-quarters of Tesla sales come from countries that are currently experiencing unsustainable wealth-boosting bubbles in some form or another. When these bubbles inevitably burst, Tesla’s sales are going to sink and the company will hemorrhage red ink like never before.

We at Clarity Financial LLC, a registered investment advisory firm, specialize in preserving and growing investor wealth in times like these. If you are concerned about your financial future, click here to ask me a question and find out more. 

Watch This Key Level In Tesla Stock – RIA Pro

Elon Musk’s erratic behavior and the price of Tesla stock and bonds have been a constant source of news headlines in recent months. The incessant gyrations have been extremely confusing to investors who are caught between excitement about the company and the sector’s potential prospects and the risks that come from the stock’s lofty valuation, increasing competition, and the CEO’s mental state. In this brief piece, I will show key technical levels in Tesla stock that should help traders put the noise into perspective a bit more.

For the past year and a half, Tesla stock has been trading in a range between its $240 – $250 support zone and its $380 – $390 resistance zone. After failing to break above the $380 – $390 resistance zone in June and July, the stock plunged to the $240 – $250 support zone, where it now sits above. After such a sharp decline, there is a high probability of a technical bounce off this support. If the stock eventually closes below this support zone in a convincing manner, it would be a concerning sign that would likely signal even further declines ahead.

Tesla Chart

Kass: For Whom The Bell Tolls ($TSLA)

5-Reasons Why I Doubt Tesla Is Going Private

One of my most important media contacts was Barron’s Alan Abelson.

In time, Alan became a very close friend – I spoke to him nearly every Thursday afternoon for almost two decades. We went to New York Yankee games together and shared a lot professionally and personally.

Some years into our business relationship I sent him a couple of books of fiction that I thought he would enjoy. Very soon thereafter I received a call back from him saying that he doesn’t read fiction anymore because what happens on Wall Street is often much stranger than the best books of fiction.

I Still Bleed Barron’s Blue, and I still remember Alan’s comments about the weird goings on in Wall Street.

And, one of the most bizarre Wall Street events occurred yesterday with Elon Musk declaring his “intention” to take Tesla private (with “funding secured.”).

After more than one hour of a halt in the trading of Tesla’s (TSLA) shares the company has come out with a release confirming Elon Musk’s interest in taking Tesla private at $420/share — a transaction valued at about $72 billion.

I have little doubt there will be NO transaction:

  • To begin with, Elon Musk has a unique sense of humor. The number 420, or 4:20 or 4/20 (pronounced four-twenty) is a code-term in cannabis culture that refers to the consumption of cannabis, especially smoking cannabis around the time 4:20 p.m. (or 16:20 in 24-hour notation) and smoking cannabis in celebration on the date April 20 (which is 4/20 in U.S. form).
  • The company’s fundamentals and balance sheet do not support a leveraged transaction. A LBO is not financeable in the current market and this is the least demanding market in history for financing. Tesla is losing money, has large capital spending requirements, is bleeding cash, has meaningful contingent product liability risks and already has $9 billion of net debt.
  • The only way the LBO could be done is if several large strategic buyers lost their collective minds and invested in the transaction. As best I can ascertain there are no such strategic buyers that exist to support this deal — though many have lost their minds on smaller transactions!
  • There was no mention of investment banking advisors or outside legal counsel in the Tesla statement. This makes me suspect of the proposed transaction. 
  • Musk recently purchased stock in the open market. I presume Musk has been thinking about a going private deal for some time, which raises potential legal (SEC) problems.

As I wrote in my previous post, Elon Musk has gone “off the reservation” after making a choreographed and random tweet yesterday.

Not only do I believe there will be no going private transaction but I suspect Musk has gone too far with his tweets and will likely pay a legal toll for it.

Facebook Follow-up: Looking At Two Other Tech Darlings

Well, that was fast.

I published an article on Monday wondering about Facebook’s valuation, and on Thursday Facebook dropped around 20% in the wake of its Q2 earnings report, putting in the worst day for a stock in market history on value lost (nearly $120 billion) basis. The report showed robust 42% revenue growth, but that number was below expectations, and, more importantly, the online social media firm warned about future revenue weakness. Facebook will have to hire more personnel to police the “bots” posting on its site, and that will cut into the firm’s prodigious margins.

In my article, I “reverse engineered” a discounted cash flow model to show that the market was assuming 6% free cash flow growth and more than 12% revenue growth for the next decade. Today’s market price for Facebook assumes a 4% FCF growth rate – a 33% reduction from yesterday’s price.

So how do other tech giants look these days? Are they all poised to tumble like Facebook? Some are and some aren’t.

Alphabet

Alphabet is often compared to Facebook. Both companies are in the online advertising business along with the ancillary business of finding out as much information about, and invading the private lives of, consumers as much as possible.

It turns out, the market is making almost the same set of assumptions it was about Facebook before its drop. The free cash flow growth rate that allows a model to arrive at today’s current stock price as the fair value for the business is 6.5% — just a bit over the 6% rate that Facebook’s stock price assumed before it’s crash.

As I said in my previous article, I haven’t studied the online advertising market, so I don’t have an opinion on whether Alphabet can grow this much. Alphabet turns a little more than 20% of its revenue into free cash flow. That makes it around half as efficient in this regard as Facebook, though Facebook’s ratio may well shrink in the future based on its need to pay more people to police its platform.

Alphabet is involved in more diverse array of business than Facebook is. Its Android operating system is in many of the world’s mobile phones. Its Internet browser, Chrome, is popular, and its subsidiary Waymo, is involved in the development of self-driving cars, though Facebook has also made efforts at driverless cars.

Growth isn’t easy to predict for companies like Facebook and Google, and the similarities implied by doing these reverse discounted cash flow models may indicate that analysts and investors, up until Thursday, had picked nearly the same growth number for both companies out of convenience.

None of this means Google is the next technology stock to tumble though. Future quarters may disappoint investors the way Facebook’s recent quarter did, but they may just as well impress the market. Everyone now will have to persuade themselves whether the optimism baked into Alphabet’s price is justified. For at least the two days of trading this week after Facebook’s stumble, it seems they have.

Tesla

Speaking of driverless cars, Steve Eisman, a manager profiled in Michael Lewis’s The Big Short, thinks another popular technology company, Tesla, isn’t doing enough to make inroads in that area. Indeed, the electric car maker has burned through more than $8 billion in cash over the last four years, $4 billion last year alone. It shows no signs of being able to generate positive cash flow.

Its current market capitalization of around $50 billion assumes one scenario (shown below) whereby it somehow produces $1.7 billion in free cash flow next year and grows that number by 5% annually for the next decade. This would be nothing short of miraculous for a company that has lost so much cash already. Perhaps it’s unwise to count Elon Musk out, but investors should think hard before sinking money into an enterprise that hasn’t been able to generate free cash flow for so long. Second thoughts are especially in order for those contemplating buying shares given Tesla’s nearly $10 billion debt load and the nearly $0.50 billion interest payments it made last year.

Conclusion

It’s hard to know if Facebook’s (and now Twitter’s) problems represent the technology sector’s comeuppance. Facebook produced more than $17 billion of free cash flow last year, and it’s still a healthy company even if investors are re-thinking past assumptions about its growth and profitability. Not all of today’s technology firms have as unlikely a road to success and to posting the profits that justify their stock prices as Tesla.