Several institutional investors have been selling their stake in Tesla Inc (NASDAQ:TSLA) stock. Should you follow them?
Whenever a stock sees a massive rally in a very short period, the stock holders are presented with a dilemma, whether to hold on to the stock or book profits? Shareholders of Palo Alto, California based electric car maker Tesla Inc (NASDAQ:TSLA) are facing a similar dilemma. Tesla stock has rallied massively this year. It is up over 62% in the year-to-date period. In the same time period, Nasdaq Composite is up by 16.%. Given this massive rally should investors book profit in Tesla stock?
Should you follow the "smart money"?
One way to decide your exit strategy is by following the institutional investors, the so called "smart money". The top institutional investors have been selling their stake in the electric car company. Fidelity Management & Research (FMR), the largest holder of Tesla stock has reduced its holdings by 3.1 million shares or 12.71%. T Rowe Price has cut its position in Tesla stock by over 44% across all funds. Oppenheimer funds completely sold out in Q2. Over all, institutional investors sold more than 10.5 million shares, or an estimated ~$3.5 billion, in 2Q17 on a net basis. So, based on the smart money flow, you should book profits in the stock, partially at least.
Does Tesla stock still have strong momentum?
Another way to decide whether to book profit or not is by checking whether the stock still has strong momentum. While the YTD performance has been nothing short of impressive, the stock is down over 10% from its all-time high it hit a couple of months ago. Tesla stock is yet to recover from the sell-off in early July after the disappointing delivery numbers and rating downgrades. However, the recent earnings and Model 3 production has allowed Tesla stock to gain some of its lost ground. Tesla stock is up around 7% since its earnings.
Tesla stock has found strong support from its 100-day moving average. The 100-day moving average has provided strong support to the stock several times, including, after the early-July sell-off and in the last couple of months. The 100-day moving average is likely to limit the downside in the stock for now. Tesla stock has also made a bullish crossover over with its 50-day and 20-day moving averages. However, Moving Average Convergence Divergence (MACD) and volume data indicate that the stock doesn't have very strong momentum.
Tesla Inc stock has huge financial and operational risks.
While technicals indicate some more upside, fundamentals tell a totally different story. The company has both high operational risk and financial risk. It has entered a crucial period, what Elon Musk has called a "manufacturing hell". Tesla is planning to ramp up its Model 3 production from 100 cars in August to 1500 cars in September. The company expects to produce 20,000 Model 3 by December. The company is planning to exit 2017 with a production rate of 5000 units per week and hit 10000 units per week mark by next year. This is a very steep production ramp and many analysts are skeptical about Tesla meeting this target. Morgan Stanley expects the company to produce mere 2000 cars in 2017. Tesla stock rally has largely been driven by the Model 3 hype. If Tesla misses its production target, the stock could see a strong correction, like it did after second quarter delivery results.
Tesla also carries huge balance sheet risk. At the end of second quarter, Tesla had over $7.12 billion in long term debt, 1.14x its shareholder's equity. While this leverage was high enough for a company burning billion of dollars of cash every year, Tesla added another $1.8 billion of 5.3 percent B- rated notes to its balance sheet, which will not only increase the balance sheet risk for Tesla but is also likely to restrict Tesla's ability to raise capital in the future.
Many have questioned the company's wisdom behind going for the debt route instead of equity to raise capital. NYU professor Aswath Damodaran in a blog post said, "It did not make sense for Tesla to raise additional capital with debt .... Adding a contractual commitment to make interest payments on top of all of the other capital needs that the company has, strikes me as imprudent."
Stock Valuation still a big concern.
Also, Tesla stock is overvalued on most of the traditional valuation metrics, a fact even agreed by Tesla CEO Elon Musk. As reported by CNBC, Musk said: "I've gone on the record several times that the stock price is higher than we have the right to deserve and that's for sure true based on where we are today." Tesla stock currently trades at a Price to Sales (ttm) of 5.6x and Price to Book Value of over 11x.
However, many defend Tesla's valuation based on future growth potential. So, does future growth potential command the current valuation? According to Aswath Damodaran, even if Tesla grows its revenues exponentially by 13x from $7 billion in 2016, in the next ten years and its EBIT balloons from -$400 million to over $11 billion in the same period, after accounting for a 10% bankruptcy risk, the stock would still be valued at $192.34. So even if revenues grow by 13x over the next decade, the stock still has 45% downside. This poses a huge risk for Tesla investors. Now may be a good time to book profits in the stock, partially at least.
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