The People vs. Tesla

Written By Briton Ryle

Posted July 16, 2018

In the criminal justice system, the people are represented by two separate yet equally important groups: the police, who investigate crime, and the district attorneys, who prosecute the offenders. These are their stories.

So, I had a Wealth Daily reader (whose name has been changed to protect the innocent) hit me up on Twitter about Tesla. The reader shared a link to a very detailed article concerning a “short attack campaign” being waged against Tesla. It’s a long read, and I will try to encapsulate the gist of it before I move on to my own thoughts on the matter. 

For starters, what does it mean to be “short” a stock? Most investors relate to investing from the “long” side. That is, we buy shares of stock on the expectation that as the company earns more, it gets more valuable, and so the shares we own will also get more valuable over time.

The rationale behind being short a stock is the exact opposite. An investor who is short a company believes a particular company is currently as valuable as it will ever be and the shares will be less valuable over time. So instead of buying the shares, the investor can pay a small fee to borrow shares, which he or she then sells. The goal is to sell the shares at a high price, and then buy them at a lower price to replace what was borrowed. 

Short selling is a perfectly legitimate thing to do. Farmers can take advantage of high corn prices by selling their crops before the harvest has come in. When oil prices run higher, oil producers can sell oil before they’ve even gotten it out of the ground. 

I’m sure we can all think of a stock or two that looked like it was a world-beater at one time but turned out to be not so hot…

Talking Your Book

When a fund manager goes on CNBC and recommends a stock he or she already owns, it’s called “talking your book.” There’s nothing patently underhanded about talking your book — it’s easy enough to understand that someone will both own and talk about a company they believe in.

But at the same time, you can’t help but see that if you recommend a stock to a few thousand people and they buy the stock, the price will go up. 

The same dynamic is in play with what’s called a “short attack.” Some big investors will sell a stock short and then embark on a smear campaign to make the company look bad and hopefully scare some investors into selling the shares, thereby driving the price lower. 

So, the article I mentioned earlier is suggesting that this happening to Tesla right now. The author alleges that there is a group of high-flying hedge fund guys who have shorted shares of Tesla and are now engaged in a smear campaign to make it seem like Tesla is not a viable company, that it is in danger of failing. Their goal is to shake confidence in Tesla and make a profit when the share price falls. 

The author attempts to draw the conclusion that the short campaign against Tesla is an attack on progress, part of a larger campaign seeking to undermine electric vehicles and renewable energy in general. In other words, the author is attempting to reframe the whole discussion into a moral question. 

Now, there are plenty of investors out there who add morality to their investments. There are fund managers who won’t own tobacco. And there are fund mangers who won’t own big oil or gun makers. That’s all fine. Invest how you want. If you feel bad about owning a company that you feel is exploitative, I have no problem with that.

But at the same time, I would urge investors not to turn a blind eye to potential problems with a company just because the company has the moral high ground.

The People vs. Tesla

Now, what’s all this got to do with Tesla? Well, as the author of the “Tesla short attack” article accurately points out, Tesla does depend on investor confidence to succeed.

Why? Because Tesla loses money and has to sell bonds in order to fund its operations.

Skeptical investors will demand higher and higher interest rates from a company they don’t trust and will eventually stop lending money via bond purchases altogether.

It is absolutely possible that a well-run short attack could undermine confidence in a company to the point that the company can’t get loans anymore. 

But instead of worrying about whether the short attack is fair or not, let’s think of it like a courtroom drama. Let’s say Tesla is the defendant. Let’s have District Attorney Jack McCoy play the prosecution and try to prove that Tesla is not a viable company, that it’s a fraud and will eventually collapse. It is up to Tesla and its defense team to prove otherwise. How does Tesla do this? 

For a company that loses money, the process is pretty straightforward. It simply has to show how costs will continue to fall and production will continue to improve until the company shows a profit. 

There’s no moral judgment here. It’s just numbers and forecasts of numbers. 

The market is the jury, and it will decide if Tesla has done a good enough job with its numbers and forecasts of numbers to decide if Tesla can continue its operations or not. 

The short attack that is currently being waged against Tesla serves a very valuable function. Tesla has missed a lot of production goals in its history. That has made it vulnerable. This short attack has pushed these issues into the market’s courtroom. And it is being judged. 

There are plenty of investors out there who will lend money to Tesla at 6% if Tesla is innocent — that is, if it can adequately address the credibility questions that have been raised. 

If not, well, in the criminal justice system, there are crimes that are considered especially heinous…

DUN DUN.

Until next time,

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Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.

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