7 risks for Tesla’s stock that Robinhood traders would be wise to heed

“If you have lived through the volatility and all the tweet storms and massive short-side attacks, good for you,” says Shawn Kim, a research analyst at Gabelli Funds who made a bullish call on Tesla when the shares traded under $300 last year.

But what to do now? Consider taking some money off the table unless you really are a long-term investor with a time horizon of five to 10 years, and you can manage through pullbacks without getting too emotional.

Musk is clearly a disrupter in the auto industry, and he is good at it. Below, we’ll go over why that could eventually make this a trillion-dollar market-cap stock, which equates to a four-fold increase.

But, near term, the stock faces seven risks.

Risk No. 1: Tesla looks pricey

“Tesla strikes me as more speculation than investing at these prices,” says Todd Lowenstein, an equity strategist at The Private Bank at Union Bank. “It’s pricing in not only massive market-share gains and flawless execution, but world domination.”

Tesla trades at 7.8 times forward 12-month revenue, he points out, compared with around 0.2 or less for General Motors GM, +4.83% and Ford F, +5.97%.

Sure, other disruptive companies such as Alphabet GOOG, -0.45% GOOGL, -0.26% and Facebook FB, +0.22% trade at similar sales multiples. But Tesla is a lot more capital-intensive so it’s not a fair comparison, says Kim.

“There’s a lot of FOMO [fear of missing out] investing. People are just piling into the stock.”

By one count, almost 40,000 Robinhood accounts added shares of Tesla on Monday.

“The stock is not trading on a multiple of today’s or tomorrow’s earnings. It is trading on a multiple of Elon Musk’s dreams,” says Robert Bacarella, who manages the Monetta Fund MONTX, +1.17%.

Risk No. 2: Tesla may raise money

It would probably be dumb not to do this. “I think they should take advantage of the market and raise capital to fortify the balance sheet. It would be crazy not to,” says Kim.

Depending on the size and pricing, that could hit the stock hard.

Risk No. 3: The electric-vehicle industry seems bubbly

Tesla is not the only electric-vehicle (EV) stock going crazy. In the past few weeks the shares of other EV plays have also risen sharply, such as Nikola NKLA, +2.71% in trucks; a special purpose acquisition corporation (SPAC) called Tortoise Acquisition SHLL, -0.72% that plans to merge with the EV heavy-duty truck company Hyliion; Apollo Global Management’s APO, +2.24% Spartan Energy Acquisition SPAQ, +2.99%, which is buying the EV maker Fisker; the Chinese EV maker NIO NIO, -4.04% ; and the EV commercial-van company Workhorse WKHS, -0.97%.

“We are in a hot market right now,” says Kim, who thinks several of these companies are just speculative bets. “There is a bit of exuberance in the sector.”

Bubbles come and go. And if this one deflates, it’ll hit Tesla, too.

Risk No. 4: Tesla faces ‘execution’ risk

You have to hand it to visionaries like Musk who think of ways to change the world and disrupt an entire sector with innovative and popular products. The problem for any disrupter in early-stage, high-growth mode is execution-risk issues such as quality control, or problems with suppliers. It’s almost inevitable. Surprise setbacks will hurt Tesla.

Especially because Musk has built up expectations by suggesting that Tesla is getting close to “level 5” full autonomy in electric vehicles. This means the full EV feature set, from active safety features like cruise control and lane-drift warnings, to full autonomous driving where the vehicle does everything.

“Autonomous driving is one of the toughest problems in artificial intelligence,” cautions Kim. “Maybe Musk is not that close, because it is such a difficult problem.”

Risk No. 5: S&P 500 inclusion is probably priced in

A lot of investors think Tesla will get a boost if it gets added to the S&P 500 SPX, +0.90% soon because index funds will have to add it. Tesla may or may not get added, but the concept has been discussed so much it is probably priced in to the stock, says Kim. Typically, by the time stocks get added to an index after much speculation, they are as likely to sell off as to rise.

Risk No. 6: The market ‘feels’ toppy

Recently, several of the dozen sentiment indicators I track for my stock letter subscribers turned outright bearish. This means they turned too bullish, a negative from a contrarian point of view. The rest are neutral. Insiders have turned neutral to slightly bearish, according to buy-sell ratios tracked by Vickers Insider Weekly.

And participation in market strength is narrowing, a possible technical sign of more weakness to come. The number of Nasdaq stocks trading above their 50-day moving averages has fallen to 53% from 90% in early June, and the S&P 500 has shown substantial declines too, says William Delwiche, an investment strategist at Baird.

“The ‘market’ is essentially Amazon.com sprinkled with some Apple AAPL, +0.68%, Microsoft MSFT, -0.14% and Alphabet,” quips Jared Holz, a biotech strategist at Jefferies.

All of this is not a screaming “sell the market” signal. But it suggests some kind of pullback is more likely now. In a sentiment shift, frothy stocks such as Tesla get hit.

Risk No. 7: Musk is showing hubris of his own

In April 2019, Tesla looked like a strong buy because of insider buying at the company, but also because sentiment was so dark that short-sellers were exhibiting over-the-top hubris, as a I wrote for MarketWatch. That turned out to be right. The stock has soared 450%.

Now Musk is doing the same thing. On Twitter, he’s taking victory laps and tweaking short-sellers who openly bashed him and his company for so long. Sure, they got crushed and made outrageous claims. So maybe they deserve it. But Musk’s sale of “short” shorts — get it? — might have been piling on, even if they sold out quickly. There’s nothing scientific about this, but Musk’s behavior is another piece of evidence that Tesla and the EV space are in a bit of a bubble.

Long-term bull case remains intact

As an investor, I like founder-run companies. Studies show they outperform, and for good reason. Visionary founders such as Jeff Bezos at Amazon AMZN, -2.43% or Mark Zuckerberg at Facebook FB, +0.22% are driven by a lot more than money. They want to change the world, and they pursue this with passion even after they make their billions. Tesla is this camp.

What’s more, Tesla is still arguably in the equivalent of the early days of Facebook, Amazon and Alphabet. Tesla could easily become a trillion-dollar company eventually, says Kim, at Gabelli.

Tesla’s growth has been phenomenal, but there is much more to come, he says.

“Tesla has proven they can produce cars and produce at scale. We are confident they will make as many cars as General Motors or Ford one day,” says Kim. “People are catching on to the green initiative, and Tesla has been leading the initiative. Their goal is to get humanity to wean off of carbon energy.”

Near-term catalysts include the continued rollout of the Model Y crossover SUV for around $50,000. This gives Tesla a more reasonably priced presence in the most popular part of the market, or SUVs. Other growth drivers include the Cybertruck due out in late 2021 and 2022, a high-end Tesla Roadster that may include a rocket-thruster option, and the Semi, a large Class 8 truck. A “battery day” scheduled for Sept. 22 may attract investors with an announcement of a million-mile battery.

Plus, Wall Street still needs to get on board. Analysts have been notoriously wrong on Tesla and they’re still skeptics, with an average price target in the upper $700 range. If they finally turn more bullish, they will draw money to the stock. We may see them turn incrementally more bullish after Tesla reports second-quarter results July 22.

At the time of publication, Michael Brush had no positions in any stocks mentioned in this column. Brush has suggested TSLA, GOOGL, FB, GM, F, APO, MSFT and AMZN in his stock newsletter, Brush Up on Stocks. Brush is a Manhattan-based financial writer who has covered business for the New York Times and The Economist Group, and he attended Columbia Business School. Follow Brush on Twitter @mbrushstocks.