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4 Reasons To Sell Tesla Stock

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I've been calling a top on Tesla stock for years. In July 2017, I suggested investors should sell Tesla on news of the Model 3 launch. Since then the shares have tumbled 12%. Should you sell now?

Before getting into that, let's look at why you should hardly ever short a stock—e.g., borrow shares, sell them in the open market, and hope you can profit by repaying the stock loan by purchasing the shares after the price has plunged.

Shorting a stock is a great idea when you are confident that the company will file for bankruptcy. Companies do that when they can't repay their debts or it's discovered their accounting is deeply deficient.

If you think a stock is going down because it can't make its quarterly numbers, it's better to make a more conservative bet by using stock options. For example, you could buy a put—paying a premium for the right, but not the obligation to sell the stock at a certain price by a specific date.

Buying a put limits your risk since if the company surprises you and makes its numbers—causing the stock price to rise, then you only lose the option premium as you let the option expire worthless.

If you shorted the stock and it went up, the broker that lent you the shares would demand immediate repayment which would force you to buy shares as they rise in the open market—causing you to suffer a bigger loss.

This comes to mind in considering the short case against Tesla—29% of its shares were sold short as of Feb. 15, according to Morningstar.

The centerpiece of the case against Tesla is its weak ability to repay debt. The Wall Street Journal reports that Tesla is "distressed."

Based on the Altman Z-Score formula—which takes into account share price, working capital, retained earnings and other items—Tesla had a score of 1.26, its lowest score for any quarter since 2014. Any company with a score below 1.8 is considered distressed by many investors. A score of 1.0 or lower suggests bankruptcy is likely within two years.

To be fair, Musk has demonstrated a circus-barker's ability to keep his audience from abandoning their belief in his super-hero-like powers.

Nevertheless, there are four reasons to bet that Tesla's best days are behind it.

1. Production targets are out of reach

To the company's credit, there is considerable demand for its Model 3—Tesla's relatively affordable electric car.

But Tesla can't produce enough of them to meet demand. It has twice set a target of producing 5,000 each week and missed both times. In April, Tesla will have a third chance to reveal whether it will meet that goal or miss it.

Musk does not seem confident. As the Journal reported, he recently told attendees at the South by Southwest festival that Model 3 production delays are costing him sleep.

There is reason for him to worry. Unnamed current and former Tesla employees told CNBC that Tesla is making "a surprisingly high ratio of flawed parts and vehicles"—which threatens the company's ability to meet its Model 3 production target. But Tesla says "it subjects every vehicle to hundreds of inspections and tests," CNBC noted.

If that is not enough stress, Musk promised earlier this year to quintuple the number of vehicles Tesla delivers in 2018 to 500,000, according to the Journal.

2. Cash is going up in flames

Tesla is burning through massive amounts of cash and if it can't generate enough from selling cars, it will need to go outside for more. In 2017, Tesla spent $1 billion a quarter in cash—leaving it with $3.4 billion by December.

Assuming Tesla keeps immolating cash at that rate, it will run out before the end of 2018. UBS analyst Colin Langan estimates that if Tesla could produce 5,000 Model 3s a week, it would generate "about $1 billion in working capital in the short term," according to the Journal.

Tesla has spent $10 billion in cash since it went public in 2010 and now has $10 billion in debt on which it faces higher interest payments. The better news is that it has $2 billion in unused credit facilities and funds.

3. Executives are fleeing

When large numbers of talented executive leave, it's a sign of problems at the very top.

Not only is this true in Washington, it also applies to business. And when a business is rapidly shedding financial executives, it could be that those executives are cooking the books or that the CEO has driven them to leave by demanding conduct that violates their professional norms.

This comes to mind in thinking about Tesla,which has lost three financial executives recently. In 2017, Tesla's CFO left and in the past few days its chief accounting officer and treasurer have departed. Bloomberg provides more details about these departures. In February, Tesla's top sales executive flew the coup, noted the Journal.

4. Investor confidence is slipping

History shows that investor confidence in companies like Enron and Theranos can rise to great heights, peak out, erode slowly, and then collapse with frightening speed.

Nathan Weiss works for Unit Economics a research arm of investment firm Weiss, Harrington & Associates which has bet that Tesla stock will fall. He told the Journal, “Some big investors are losing patience. They are less excited about it than they were a year ago.”

Three of Tesla’s 10 largest shareholders have recently sold Tesla shares. According to its quarterly filings, Fidelity Investments which behind Musk is Tesla's second largest shareholder -- holding 10% of the stock -- sold nearly 33% of its shares in the final three quarters of 2017.

But not everyone is bearish -- T. Rowe Price more than doubled its Tesla stake in the fourth quarter, making it the fourth-largest owner of Tesla shares, according to the Journal.

It looks to me like confidence is slowly eroding. And if the market learns next month that Tesla can't make 5,000 Model 3s a week— which seems likely if Bloomberg is right that by March 16, output had "actually slowed from February when it was producing something like 936 Model 3s a week"—investor confidence could collapse suddenly.

On the other hand, if Tesla is able to exceed investor expectations, those who are short the stock will be scrambling to buy—driving up its price and yielding sweet revenge for investors who can't quit Musk.

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