Did you know that, for one day, Volkswagen was “the world’s priciest firm” in the stock market? On October 28, 2008, the stock soared more than 93% on news that Porsche had acquired a 74% ownership in Volkswagen. Volkswagen shares didn’t surge because it was a fundamentally sound company with years of significant upside ahead, but because it had been heavily shorted.
Following the announcement, short sellers were forced to pay up to 1,005 euros, as there was less than 6% of the voting stock still available in the market. Very briefly, the company’s market cap soared to 296 billion euros, or $370 billion in U.S. dollars, which was more than Exxon Mobil’s $343 billion market cap.
This short squeeze was later dubbed the “mother of all squeezes.” Porsche made more than $10 billion in just a few weeks while hedge funds who had shorted Volkswagen lost more than $30 billion. What was supposed to be a very low-risk trade turned into a “short squeeze to infinity.”
Now, for those who don’t know, a short squeeze is essentially when traders who were betting that a stock was going to drop are “squeezed out” of the trade if the stock moves higher. In order to short the stock, they had to essentially borrow the shares on margin, then sell them to someone else. If the stock goes too far up – and their positions go too far in the red – their brokers will come knocking to collect on this “loan.” As a result, the short sellers are forced to close out of their positions and buy the stock, which drives the stock price even higher. Think of it like shaking a can of soda and then opening it – the soda practically spurts out and makes a huge mess!
Short squeezes tend to be triggered by good news, like a strong earnings report. And that’s exactly what happened with Tesla (TSLA).
On October 23, Tesla reported adjusted earnings of $1.86 per share. This was down 36% year-over-year from the adjusted $2.90 per share earned in the third quarter of 2018. However, this was still well above the estimated loss of $0.42. So, Tesla posted a profit and a 542.9% earnings surprise. Revenues of $6.3 billion were just shy of expectations for $6.33 billion.
The stock surged 20% the following day.
What’s important to understand here is that Tesla has been a pretty unreliable company. CEO Elon Musk is all over the place, executives don’t stick around for very long, and the company is constantly burning through cash. So, Tesla made for a pretty great stock for short sellers. In fact, it was the most profitable short mark-to-market. Short sellers made $2.03 billion! Come October 24, though, short sellers lost $1.4 billion in just a few minutes. So, the shorts had to run for cover, which drove up the stock price even more. Thus, the short squeeze.
The truth of the matter is that Tesla isn’t exactly a fundamentally superior stock. Yes, the company turned a profit in the third quarter, but U.S. third-quarter sales – and Tesla’s biggest customer – actually sank 39% year-over-year from $5.13 billion to $3.13 billion. Sales in China increased 64% year-over-year to $669 million from sales of $409 million in the third quarter of 2018.
There’s also trouble in paradise with its battery cell maker, Panasonic. According to a Wall Street Journal report, the companies are fighting over the Tesla culture, the battery cells’ price tag and the tight production timeline.
Their battery plant is actually outside of my office in Reno, Nevada. So I know quite a few people who work at that plant, and I can say that morale is very poor there because Panasonic hasn’t made a lot of money on the batteries. Plus, a lot of folks at Panasonic are homesick for Japan. And, of course, Panasonic’s not going to be the exclusive battery cell provider for Tesla anymore.
But it’s more than just a couple’s squabble and shifting sales; there’s also the fact that it’s an incredibly expensive stock. Tesla has a high price-to-sales ratio. So if you buy a $100,000 Tesla Model S, the company’s market value should go up $900,000 because they trade literally nine times sales. I can’t even get a P-ratio because the forecasted earnings are not positive.
Not only that, but the competition between Tesla and other car manufacturers is heating up. If you’re looking for a semi-autonomous car, you can buy an Audi, a Volkswagen or even a Porsche. (The Porsches are a little expensive, but a cheaper version is on the way.) Audis are competitive with Tesla right now, and they’re selling their cars where they can really squeeze Tesla.
What happened with Tesla post-earnings is exactly what we’ve seen with value stocks. We talked in broader terms about the mean reversion rallies/short covering on Thursday, and what happened with Tesla is an excellent example of that.
The bottom line: Good and bad companies are seeing their stocks climb higher.
That’s what was really behind TSLA’s 20% post-earnings surge. It wasn’t because something stunning came out of the earnings report that showed that the company had real staying power, but rather a really big short squeeze.
The truth of the matter is Tesla just isn’t a very good long-term growth stock. If you plug it into my Portfolio Grader, its Fundamental Grade is a D even after its third-quarter earnings report and its Quantitative Grade is a C, as buying pressure has increased a bit. So, the stock earns a C as its Total Grade, making this stock a “hold” right now.
Where to Park Your Hard-Earned Money
You see, when investing in the stock market, it’s not about investing in the “cool” company or the disruptor. Invest in healthy companies with strong underlying fundamentals, sales and earnings that will drive them higher over time.
And that’s exactly what I do in Growth Investor.
My Growth Investor companies are all fundamentally superior, and when they report earnings, they jump because there is significant future upside and not because short sellers are simply running for cover.
My Growth Investor companies like DexCom, Inc. (DXCM), Fair Isaac Corp. (FICO) and Ubiquiti, Inc. (UI) surged about 40%, 16% and 45%, respectively, following their better-than-expected earnings. Plus, my play on the artificial intelligence (AI) boom came close to a new 52-week high after crushing analysts’ earnings and revenue forecasts.
This isn’t surprising given the huge potential in AI right now – from healthcare to retail to self-driving cars.
I call this stock the “Master Key.” Think of it like a single key that can unlock any door in a giant building.
It’s known as the “Volta Chip” – and it’s what makes the AI revolution possible.
Now, you don’t need to be an AI expert to take part. I’ll tell you everything you need to know, as well as my buy recommendation, in my special report, The A.I. Master Key, exclusively in Growth Investor. The stock is still under my buy limit price – so you’ll want to sign up now; that way, you can get in while you can still do so cheaply.