Wednesday, October 14, 2015

Tesla Once Again and "Short-termism"

            To follow up on the previous post, let’s consider Tesla, the other stock that has been consistently discussed here as being overvalued.  Before getting to valuation, it is worth noting that Tesla is one example among many that contradict the view that the market is “short-term oriented.”  It is surprising how often this evidence is ignored in light of the fact that concern regarding "short-termism" has even spread to presidential candidates.  The fact is that all Tesla offers in the short-term are small profits or losses.  Nothing that can remotely justify its $30 billion (or so) valuation.  The only way to rationalize that valuation, particularly in light of the difficulty of growing rapidly in the automobile industry, is to conclude that the market is taking a very long view with respect to Tesla.  It sees big profits in the distant future.

            But then why does Tesla react, in some cases quite strongly, to short-term information?  To start, if what is meant by short-term is current information that is all there is.  Given that all new information is current, the relevant question is whether the current information has long-term implications, at least in the view of investors.  And that turns out to be an extremely difficult question to answer.

            A big reason for the difficulty is that information can accumulate and then suddenly have an impact on long-term views when a critical juncture is reached.  For instance, Tesla investors may largely ignore bad short-term news such as delays in the Model X for a while.  But if that news accumulates, at some point it will undermine their confidence in the company’s long-term growth.  At that point, the stock price will collapse.  However, there is no objective way to measure how information is accumulating in the minds of investors or what their thresholds are.  This is what makes shorting stocks such as Tesla so risky.  There is no way to predict how long it will take for investors to change their minds or what type of information will cause the change.  Eventually, of course, the stock price must drop if it becomes clear that the expected growth in future cash flows will not be realized.  But eventually can be a very long time.  As long as investors believe that future growth is coming, the stock price will not fall.

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