Why is Tesla share price dropping?
Disclaimer: this is not investment advice. Before taking any investment decision, do your own research.
To be clear: I don’t know. This article is a response to the most common cited reason, “Twitter overhang” which, in the most part, I think is bad reasoning.
First lets see the merits of this idea.
Twitter overhang
I see three general influences from Twitter deal into Tesla that people quote, which have some merit but are absurd to consider compared to the macro and momentum reasons I’ll write about below. In order of importance (according to me):
Elon Musk selling shares. This has a small direct impact compared to other sellers, but it’s reasonable to believe that seeing Elon selling has a large influence on shareholders in general. My argument against this point is that Elon would be selling anyways, although maybe less shares. The main reason Elon is selling is the same reason smart money has been selling: fear of macro and margin debt (will expand on this bellow.)
Elon Musk saying crap on Twitter. This is an easy one: without a Twitter deal Elon would still say crap on Twitter (or some other medium if Twitter failed.) I sympathize with people wanting him to stop, but anyone following him for long enough knows that it’s just how he is and understands that he successfully runs companies no matter what he says. Also, I come to learn to pay attention to his crap because most of the time there’s well thought out reasons behind them. He is impulsive at times saying things in an unproductive way, but I find it best to check my own understanding of a subject if I find him saying something outrageous.
He will lower his outrageousness at some point, or maybe everybody will get more used to it. In any case, it will seem like less important.
How he handles Twitter will affect his brand, including Tesla. This one I believe will turn around. The way he handled the deal was awful for sure, but much of what was outrageous since then will be seen as brilliant soon enough. Specifically, people were calling him dumb for reducing head count by 75% and thinking the company could still run and shutting services without understanding what they did. Some decisions were dumb for sure, but finding out who and what is needed would require some try outs that would break services. The fact that Twitter is still working and, for quite a lot of people, actually improving is evidence enough that it wasn’t as dumb as people commented.
In the longer term I believe that the opinions that count the most will see the way he’s handling Twitter as brilliant, making it one of the greatest turnaround in history (Apple being the clear winner on turnarounds.)
More important reasons for the drop
If Twitter and Musk have little to do with the heart-wrenching drop in TSLA price, what are the more relevant reasons for such a drop?
My short answer: macro + momentum + margins.
The macro part is simple but not well understood.
Cars are mostly purchased on credit. If rates are going higher, the cost for a car increases as a portion of income. That at moment where people are getting nervous about the stability of income.
The second part of macro and rates affecting TSLA is the fact that its business is a capital intensive one. Any problem with the business will be affected by Tesla’s capacity to get loans at low rates. With the FED increasing rates, that capacity is affected.
The momentum part is more tricky. Momentum is the idea that, because mainly of technical analysis trend following strategies and success bias, once a stock is trending down (or up) it’s more likely to continue in that direction. That’s because technical inclined traders have as the most important principle “follow the trend.” And because all the successful traders will continue doing what took them there which, in the case of TSLA, is shorting it. The momentum will continue until there’s enough non-momentum traders and investors that believe the risk/reward on Tesla is worth going against the momentum traders and the macro outlook. Difficult to know when that will be.
Finally, the margin part is the less understood and most important part of bear markets to get a handle on. Margin debt is a loan that the broker gives clients using equities in the account as collateral.
For retail accounts, the margin limit is 50%, which means that the broker will lend clients half of the equity in the account. Half of your shares are actually own by the broker. In down markets, equities prices get lower and the debt goes over the 50% limit and a margin call is generated. Clients are forced to deposit more funds or get liquidated.
With large accounts and specially insiders accounts that have restricted trading, the margin limit is usually lower. In a down market, insiders that use margin debt heavily to finance day-to-day life and investments may find themselves getting margin calls or too close to a margin call for their comfort. So it should be expected that this accounts sell a percentage of shares to cover margins during bear markets. This may happen even when the margin debt is a very small percent of the account initially. For example, if Elon Musk had a 3% margin debt at all time highs (~420), when the stock hit 1/3 of that price (140) the margin debt would represent 9% of the account, which would definitely feel uncomfortably high, specially when expecting a year or two of uncertainty in both Tesla’s business and markets.
Important milestones
There are important milestones to consider to try to guess at what point TSLA price will turn around. But always consider that the business can change with the next FSD release, next deliveries announcement or any product announcement that surprises market participants. So even when it’s important to consider what’s currently happening with the stock, it’s also important that it can change at any moment. In that sense, the usefulness of this milestones is more as entertainment than as an investment decision tool.
The first milestone is a psychological one: markets like to dwindle around round numbers, and 100 USD is one of the more prominent ones. Personally I don’t see the price staying too long at that price. There’s some technical history around the psychological 100 barrier from 2020, but that was a short period. The more technically salient 150 price was perforated like paper, so wouldn’t count on much resistance around 100. Only point in favor of a pause now is that oversold indicators are much stronger.
Second milestone is a trailing twelve month P/E of 20: I see 20 as an important psychological barrier on valuation. A P/E ratio under 20 is very uncommon for a company growing at over 50%. 20 P/E marks in my mind the point were Tesla is absurdly cheap. To get there, we can either have lower prices or higher earnings. Since earnings only come out every quarter, the price is the faster variable to adjust. For 20 P/E with earnings from the last 4 quarters the stock price would have to go down to 64. If it takes longer to get there, it may include Q4 earnings which may take the price to 75 or 80 to get the same 20 P/E.
Just before the 64 milestone there’s another important psychological target: 70 USD is half of the 140 level that a lot of participants were paying attention to for being 1/3 of the ATH (which was also perforated like paper.) And just 1 dollar away is the very important 69 price that makes quite a few TSLA fans smile.
At around 60 we have the pre-Covid top.
After the sixties, there’s nothing important to stop the drop until 42 (another fan number) and the low 30s where the Covid drop found some support.
Some argue that TSLA should go back to the 12–24 range that had before all the bubble frenzy. There’s some value to this point of view in that quite a few technology companies have gone back to prices before 2020 and even back to 2017. But that’s thinking by analogy (all tech companies are going back to 2017–2019 prices, so should TSLA), which ignores all what makes TSLA something very different.
Fundamentals
All this article is based on reasoning on general market concepts with very little insight on Tesla’s business.
It assumes pricing TSLA lower because it’s a capital intensive, rate-sensitive business, not considering its unexpected growth this year so far and it’s adaptability (e.g. chip shortage.)
It assumes momentum trading based on price action, which has nothing to do with what actually happens with the business.
It assumes margin debt, which at this point in the bear cycle I believe should be minimum. Anybody that has good risk management should have closed margin debt by now. And the ones that are clueless should have been liquidated or soon to be.
I still think that Tesla’s result will surprise with growth in a very difficult environment, although I’m now not sure that bottom line growth (earnings) is guaranteed all through 2023. If Tesla keeps growing deliveries without losing money in the next few quarters, the basic idea of how higher rates should affect its business will be challenged. And overcoming the macro headwinds will likely turn around the momentum into an uptrend. Problem is timing.
In the meanwhile, I hope that everybody that has optimistic long term expectations for Tesla can take advantage of this unusually low price.
And, as always, avoid margin.
The following sections were added after publication, on the next day after a conversation with my pillow.
Turn around
Bear markets have many rallies that make people regain hope and end up crushing them at the point when they discount the bear market as done. I mention this because although I feel that under 210 Tesla’s risk/reward started to be clearly in favor and that at the current 110 is a bargain, there’s no real limit on how low the stock can go. We could argue that liquid assets is a strong limit (which would mean a price of about 6 USD) but even that can evaporate fast if the business is struggling.
Short term I expect a rally in Tesla. I already mentioned the oversold indicators. It’s also unlikely for any stock to go straight down, even when the business is broken (look at CVNA and NKLA last year for examples.) But don’t get comfortable. If a strong recession is brewing, volatility is almost guaranteed and the bottom may be far away.
There may be a rally based on earnings results, energy deployments or some other positive surprise that breaks the downwards momentum. But as long as high rates is what dominates the macro outlook, the pressure down will keep increasing. The only moments Tesla may show that it’s exceptional and that the macro fears may not affect it as much as expected are the quarterly deliveries numbers and earnings results. In between, I expect a lot of pain.
Unless there’s a major breakthrough, like a realistic timeline for robotaxis, I fear that Tesla will suffer a longer downtrend with short periods of very strong rallies. This will be a very difficult market to make directional calls in. Focusing on quarterly results and long term valuation will help keep sanity.
How low can the market go?
Strong bear markets are hard to remember because they don’t happen very often. Any market participant that started investing or trading after 2010 doesn’t know what a bear market feels like. And for most that did experience the 2007–2009 bear market, the exposure is likely very different, which makes the experience quite different.
Because of this lack of experience in market participants, it’s common to see them thinking “How much more pain can this bear market inflict?” at each new drop lower.
The difficult answer is that we may be only about half-way through. The best measure of valuation I know of is Shiller’s Cyclically Adjusted Price Earnings ratio. Values over 25 are clear bubbles to me. Need to lower prices another 10% for the S&P 500 to get under that threshold. A value under 20 is healthier, which would mean a 30% drop. 15 could be in the cards with a strong recession, which is another 50% drop away.
Short answer: it can drop to much lower levels.
2023–04–21 review note
Much of this article has worked out well so far. Want to add some new information on technical price points and earnings (along as some aesthetic cleanups on the original article.)
Earnings
Based on the 2023Q1 earnings call, it seems likely that Tesla will sacrifice profits and cash flow for unit growth. I agree with the strategy, but this will likely cause some share price pains. Above in this article, I wrote that a 20 PE is good mark for “cheap”, but what happens with that logic if earnings drop in half? Suddenly, a 20 PE means a price of 30–40. If it starts to have negative quarters or no profits the logic fails completely and the only factors for price limits are technical and future expectations.
Future is bright
It’s not hard to see Tesla producing more than 5 million vehicles in 3–5 years and making at least a 5,000 dollars net profit per vehicle (for context, it made 8,385 dollars per vehicle in 2022Q4) which would be total earnings of 25 billion, double what they made in 2022. With PE of between 20 and 50, that would mean a price of 140 to 350. And that is conservative (Tesla should be producing closer to 10 million vehicles in 5 years) ignores more rosy valuations (we had 1000 PE on 2021, which I don’t expect to repeat) and other sources of income, like energy, insurance and autonomy. A little more optimistic view could easily take it to a 280 to 2000 range in 2027, without the Robotaxi moonshot.
At less than 100, it is quite a bargain for people that have high confidence in Tesla. That will create some support based on business only. It may even make buybacks a reality.
Macro
On the macroeconomic view, a recession some more likely now although there’s still uncertainty on how bad it will be. Market seems to be betting on a soft recession (or no recession) and FED pivot, which is a highly unlikely to me. The only way I see FOMC cutting rates significantly is if risk of depression seems likely (similar to 2008), which will mean lower stock prices anyway from business decline. Because of that, I expect lower index prices at some point in the next 12 months, maybe back to the June lows or even lower. I keep my 20 CAPE (S&P at ~2800) as reasonable entry target and 15 CAPE (S&P 500 at 2150) as panic cheap target.
Technical crystal ball
I agree in general that Technical Analysis seems to be like the astrology of traders. But the self-fulfilling prophecy aspect does give some value for choosing specific price targets and it does give information on momentum. Based on TA, the 100 price levels has gain more salient resistance since it’s where the drop stopped last time. Before that, the 140–165 range seems like a place for some bulls-bears tug-of-war. Below 100, I keep the psychological 69 and 42 important price points and below that, the 12–24 price range. But I don’t see prices under 69 to be likely. Just less surprising than when I wrote the article.
Conclusion
Be prepared for testing 100 USD again, not surprised if it goes down to 69. And try to consider prices below 42.
Not investment advice. Do your own research. Be careful with margins.
