During the initial phase of the U.S. occupation of Iraq after 9/11, Secretary of Defense Donald Rumsfeld gave a speech to troops. In it, he said:
There are known knowns. These are things we know that we know. There are known unknowns … things that we know we don’t know. But there are also unknown unknowns. There are things we don’t know we don’t know.
Those “unknown unknowns” could have a profound impact on the future. But you can’t incorporate them into your decision-making.
This makes unknown unknowns particularly dangerous to investors. Your portfolio could be sailing along nicely when suddenly something happens that you didn’t anticipate.
At best, you could lose some previous gains.
At worst, you could suffer a complete round trip.
Last week, strategists at Blackstone released their annual list of “10 Surprises.” These are things that most investors aren’t thinking about … but could happen this year.
That gave me an idea.
I’ve long been bearish on Tesla (Nasdaq: TSLA).
Yes, the stock has appreciated dramatically in the last two years. But those gains are purely speculative. They’re not based on a rational analysis of the company’s business prospects.
TSLA is a stock that’s priced beyond perfection.
If ever there was the time to review unknown unknowns, this is it.
A Precarious Position
Whenever I think about an overpriced speculative favorite, I think of the Grinch with all of
Whoville’s toys at the top of his mountain.
A lot can go wrong in that position.
TSLA is in that position.
Consider a few random facts:
- The company’s market cap increased by $500 billion last year. At $800 billion, it amounts to over $1.6 million per car sold in 2020. For General Motors, that figure is $9,000 per car.
- Tesla is now worth more than Volkswagen, Toyota, Nissan, Hyundai, GM, Ford, Honda, Fiat Chrysler and Peugeot combined.
- It holds 18% of the global electric vehicle (EV) market, but only 0.5% of the global auto market.
- The next three companies by EV market share (Volkswagen, BD and BMW) sell as many EVs as Tesla does.
- The company’s increased sales in 2020 were entirely due to its new China operation. In Europe and North America, its sales collapsed by 32% and 38%, respectively. As EV investors know, the Chinese market is crowded with competitors, including NIO (NYSE: NIO), XPeng (NYSE: XPEV) and Li Auto (Nasdaq: LI). All those companies are producing vehicles that cost less than a Tesla.
- At its current price-to-earnings ratio, TSLA investors will have to wait 1,767 years to see their investment rewarded by earnings.
I could go on, but you get the picture.
Not only must everything go perfectly for Tesla’s current plans. Nothing unexpected can happen either.
Tesla’s Unknown Unknowns
With that in mind, what could upset Tesla’s applecart?
Remember, this is just speculation. But it’s informed speculation. All these things are perfectly possible.
- Congress passes a series of stimulus and infrastructure spending bills in February and March. Markets react to the expectation of resulting inflation by selling long-dated bonds. Interest rates rise across the board, significantly reducing the attractiveness of growth stocks, including TSLA, which suffers a 20% sell-off.
- A small research and development company announces a breakthrough that reduces the cost, weight and size of EV batteries. It turns out that the company has prior agreements with several EV makers, who announce plans to use its technology, dramatically reducing the cost and improving the performance of their products. This leads to another significant TSLA sell-off. By the end of the year, Tesla is under substantial pressure for market share, especially in China.
- Investors pan Tesla’s Battery Day in September, noting that, for the second year running, the company has no significant advances to report. Instead, CEO Elon Musk doubles down on his plans to focus on lithium mining and manufacturing batteries in-house. Noting the implications for cash flow and profitability — current margins are only 1% — investors sell TSLA for another 20% decline.
- Despite the sell-offs, Musk decides to build market share through acquisition, launching a bid to buy Volkswagen. VW rejects the bid. Musk reacts with a series of increasingly unbusinesslike tweets. The Securities and Exchange Commission concludes that Musk has violated his agreement with them. Tesla’s board steps in to relieve him of some of his responsibilities. The market reacts with yet another sell-off.
- By the end of the year, Tesla has lost 70% of its market capitalization.
The Bigger They Come, the Harder They Fall
Reggae great Jimmy Cliff made a great point with his 1971 hit of that name.
It’s true. Look at this chart of Microsoft from mid-1998 to mid-2000:
During that period the company didn’t do anything wrong.
It just got caught flat-footed by a bunch of unknown unknowns that added up to the dot-com bust.
So, as we start a new investing year, it’s the perfect time to scan the horizon for unknown unknowns in your own portfolio.
You might want to start with positions that have appreciated dramatically in a brief period without the fundamentals to support that in the long run. Tesla is one example.
After all, as Jimmy Cliff sang, “the bigger they come, the harder they fall.”
Kind regards,
Editor, The Bauman Letter
