It seems like just about every other week Elon Musk and his company, Tesla Motors, are in the news for one reason or another. In fact, the company’s stock has seen a huge surge in price to begin 2020. After Monday’s close (February 10th, 2020), Tesla’s stock is now up 84.44% year-to-date.
Since Tesla’s initial public offering (IPO) in June of 2010, the company’s stock has been one of the hottest for the last decade, rising from $17 at its IPO, to February 10th’s close of $771 (+4,435%!). Based on this information, one might believe Tesla to be one of the most innovative and profitable companies out there.
Innovative? Definitely. There is no question Tesla’s all electric car shook the auto industry and pushed more companies into the electric vehicle market. But, is Tesla a profitable company? Far from it.
Tesla’s net earnings for the last few years have been… less than ideal. In fact, the company has been far from turning a profit. Since the year Tesla went public (2010), Tesla has failed to report net positive year-over-year earnings. That’s 10 consecutive years of negative earnings. Take a look at just the last 3 reported years (through the end of 2018 since 2019 has not been fully reported yet):
|YEAR||NET REVENUE (LOSS) IN MILLIONS|
From 2016 through 2018, Tesla as a company lost over 3.5 billion dollars. Through the first 3 quarters of 2019, the company has reported net losses of ($967 million). So, for a company that has reported losses of nearly 4.5 billion dollars over the last 4 years (2016-Present), its stock is up 221%.
Let’s compare that to other auto manufacturers like Ford and General Motors, who have profited money every single year since 2011 (Tesla’s first full year as a stock):
|COMPANY||2018 WORLDWIDE UNITS SOLD||2018 NET REVENUES (LOSS)|
|Ford||5.3 million units||$3.7 Billion|
|GM||8.5 million units||$7.9 Billion|
|Tesla||350,000 units (2019: 367,000)||($976 Million)|
Ford and GM are auto giants compared to Tesla. Each company produces and sells millions of vehicles worldwide, profiting billions of dollars. Tesla, on the other hand, sells far less vehicles and has only ever reported losses.
Now here are their average stock returns from 2011-Present (Monday, Feb 10th, 2020):
|Average Yearly Return||-3.3%||+1.70%||+40%|
|Growth of $10,000||$7,113||$11,871||$289,864|
So, while Ford and GM each profited several billion for 2018, and have every year since 2011, Tesla, which has lost money every year, saw its stock value increase dramatically.
Now, here is the real shocker…
Tesla’s market capitalization (company equity value; equal to shares outstanding multiplied by price) is larger than Ford and General Motors COMBINED.
That’s right. A company that has reported several billion dollars in negative revenues and sold a small fraction of the number of cars, is larger than auto giants GM and Ford combined. So, the question is: are stocks and companies the same?
Companies are driven by profits and earnings. When you own a company, your earnings are dependent on the company’s profits. If the company makes money, you make money. If the company loses money, you’ll have to put more money back into it.
Stocks, on the other hand, are driven by law of SUPPLY and DEMAND and investors’ beliefs about the future. If the demand for a stock is greater than the supply, the price will increase. If supply is greater than demand, the stock will decrease in value.
Owning a company and owning a stock are two completely separate animals. Company fundamentals are, at best, a lagging indicator. Just because a company like Tesla loses money every year, does not mean its stock won’t stop going up. In fact, Tesla could make money this year, and its stock might go down. It all depends on supply and demand, not company fundamentals.
The goal of investing is to generate compounded returns. An interesting note to point out is the process of how Tesla’s market capitalization became larger than Ford and GM combined.
This was primarily due to the benefits of compounding. A $10,000 investment in 2011 would have grown to $289,864 today. In just the last two months alone, the value of the stock has doubled. So, two months ago, the investment would have only been worth $145,000.
In order for $10,000 to grow to $145,000, Tesla’s stock would have had to double a little over 3.8 times ($10,000 -> $20,000 -> $40,000 -> $80,000 -> $145,000). Each time the stock doubled in value, the investment was coming off of a larger base. In other words, it took $10,000 doubling just shy of 4 times to get to $145,000, but only had to double one more time to turn into $290,000.
Each time the share price doubled, the percentage return was the exact same: 100%, but the dollar value of a double exponentially increases every time. That is how Tesla’s market capitalization became so large: the benefit of compounded returns.
Companies and stocks differ dramatically from each other. Companies are driven by their profits and earnings. Stocks on the other hand, are driven by investor actions and beliefs (supply & demand). That is why you can have unprofitable companies skyrocket in price, while profitable companies can falter. Now, for a company to exist long-term, certainly the fundamentals have to be there, but this can take years to occur. Company fundamentals add little value when it comes to investing in liquid securities.
This leads us to a larger topic: managing our investments. Conventional wisdom will dictate that we buy and hold strong companies. Oftentimes you may even hear an investor discussing how they hold a stock because it pays a good dividend. Well, both GM and Ford pay dividends and Tesla currently does not. Both GM and Ford are solid companies, but investors have not placed much confidence in them for the last decade, and thus their stocks have struggled in what has been a relatively good market. Tesla, on the other hand, has exploded in value, even though the company has not posted a profit.
The goal of every investor is the same: to generate compounded growth. Each time Tesla’s share price has doubled, the double has come off of a larger base, and therefore the most recent double is an exponentially larger dollar value.
All stocks and other liquid traded securities will experience both bull and bear markets. Tesla is going through what is unquestionably a parabolic advance. All parabolic advances will eventually end the same way. Today, Tesla is worth over one hundred billion dollars. That is its real-time sale price. But, just like every other stock in the history of markets, it will eventually experience a large decline, where compounding will work against it. All it takes is a quick 50% drop in value to erase an exponential advance that took years to accumulate.
Successfully managing an investment portfolio for the long run requires sophisticated processes and applications. A strategic buy and hold portfolio, even one composed of sound, profitable companies, will eventually fail when the next bear market comes. That strategic portfolio will see years of savings and growth lost in the blink of an eye and require multiple years just to get back to breakeven.
Since securities are liquid; driven by supply and demand; and will all experience both bull and bear markets, an investment portfolio must be adaptive. Being adaptive means having a system for identifying securities that show the optimal supply and demand characteristics, today. It also includes combining these securities into a portfolio that is an efficient portfolio—one with low volatility and an optimal benefit of diversification.
The characteristics of securities, markets, and strategic portfolios will change overtime. As markets become more volatile, and securities show more bearish characteristics, a fixed portfolio will become much less efficient. Portfolio efficiency is a moving target- an efficient portfolio in a bull market may look much different from one in a bear market. An adaptive portfolio adjusts its holdings and allocations to reflect changing market environments and maintain portfolio efficiency.
The goal of an adaptive portfolio management system is to limit the downside to normal bull market corrections of about 10%, but also benefit from growth in bull markets. Successfully doing this can more easily result in the goal of long-term investors: compounded growth.
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