WHY TESLA'S STOCK PRICE IS VOLATILE

If you’ve had a look at Tesla’s stock price chart, you will know that the stock is one of the most volatile around. Between mid-2017 and November last year, the stock traded in a massive 36% range between $250 and $380. Since then, the stock price fell 50%, to $180, before jumping 66% to $300. So why all the volatility?

Volatility results from uncertainty. When future earnings are reasonably predictable, a company’s share price will trade within a narrow range. However, when the future is unpredictable, stock price volatility is the only certainty. In Tesla’s case, opinions are deeply divided and strongly held – for several reasons

Reinventing the automobile

Tesla was founded in 2003, but its first vehicle, the Roadster, was only launched in 2008. The Model S, launched in 2012, put the company on the map with its impressive styling and features. The idea of an EV (electric vehicle) is not new, but Tesla made EVs cool.

Rather than simply electrifying the car, Tesla chose to redesign passenger cars from scratch. In addition, the company brought a new level of styling and sophistication to the car market and introduced innovative features not previously available.

Every time there is a software update, Tesla vehicles become more efficient and new features are added. This makes them the only car to actually get better with time. Tesla is also at the forefront of automated navigation.

Based on these factors, there is a lot to like about Tesla. But from an investors point of view, a company also needs to be profitable – something we will get to shortly.

Elon Musk

One of the biggest factors driving sentiment is Elon Musk, the founder and CEO of Tesla. Musk is an inspirational figure and is prepared to explore new frontiers that few others dare consider. He was one of the founders of PayPal and founded Space X and Solar City – all innovative, ground-breaking companies. He is widely considered as a visionary, and some investors would back anything he was involved in.

However, Musk is also seen by many as a liability. He has created a string of PR and legal issues for the company and had to be forced out of his role as chairman as well as CEO. He also sets unrealistic goals, which the company struggles to achieve.

Is Tesla an auto company or a tech company?

Another issue of contention is assigning Tesla to a sector. Automobile companies traditionally have very low margins – though earnings are relatively predictable. Tech companies have very high margins, but future earnings can be hard to predict. Auto companies trade on low valuations, while tech companies trade on much higher earnings multiples.

There are good arguments for viewing Tesla as a tech company, but at the end of the day, it is also still an auto company. So, we end up with a company with low margins, trading on a valuation that makes it comparable with tech companies. In this respect, it struggles to keep up and justify the loft valuations.

Profitability

Most companies have fairly consistent margins. They may rise or fall gradually over time, or they may oscillate within a 2% range, but they don’t jump around. Tesla’s gross margin (sales minus cost of sales) is becoming more consistent, but unfortunately, it’s not very high at 16 to 18%.

When it comes to the operating margin, Tesla has never actually been profitable for a calendar year. The operating margin is also quite volatile, and the trend is not clear. It is edging closer to profitability, and over the most recent 12-month period the operating loss was just 2.8% of sales. The problem is that when margins are jumping around it's difficult to tell what will happen in the next 12 months.

Tesla should become profitable in the next few years, but just how much cash will be generated remains to be seen.

The lovers and the haters

The last, and possibly most important, dynamic is that there are two very passionate groups of people in the market; Tesla’s supporters and Tesla’s haters.

The permabulls believe that because Tesla sells very good cars, and because the world is moving toward renewable energy, Tesla will ultimately prosper. This group are prepared to support Tesla although it has lost money for 10 straight years. They see any dips in the price as an opportunity to buy.

The haters believe – very strongly – that Tesla’s business model is fundamentally flawed, and that it cannot be profitable no matter how many cars it sells. Some even believe the books have been cooked and the entire enterprise is a fraud.

Many in these two groups will never change their mind, regardless of what happens. This means they often hold leveraged positions, and when the price goes the wrong way, they become forced buyers and sellers. This increases volatility further.

Conclusion

There are not many stocks with as many dynamics as those driving Tesla’s share price. Nobody knows how this plays out, but it is worth noting that if the price falls far enough, one of the tech giants would probably buy the company. It is therefore unlikely to fall to zero, but how far it might fall is hard to tell.

With so much uncertainty, investing in Tesla for the long run is highly speculative. However, volatile stocks like Tesla make excellent trading vehicles, especially for CFD traders. You don’t need to have a long-term view to trade opportunistically. The trick is to enter when the price reaches extremes, and sentiment begins to turn. Don’t become fixated on being long or short – rather take the other side when either side is likely to be wrong.  

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