On Thursday, I was in New York City at the Market Technicians Association’s 44th Annual Symposium. I was able to meet and talk to several professionals, including hedge fund managers, traders for investment banks and market makers on Wall Street.

But it was what professor Aswath Damodaran explained that I want to share with you today.

His keynote speech, “Pricing Versus Valuation,” was focused on the fact that price doesn’t depict valuation often.

It’s the concept that a stock could be overvalued, but its price will continue to climb even though the fundamentals don’t really support it.

One of his examples was Tesla, the automaker with a cultlike following.

A Fundamental Problem

Don’t get me wrong: I’m a big fan of what Tesla Inc. (Nasdaq: TSLA) has accomplished. So much so that if you ask my 7-year-old son what kind of car he wants to drive when he turns 16, he’ll tell you “a Tesla” without hesitation.

(I may have talked up the cars’ attributes — electric, luxurious and self-driving — from time to time.)

So I get the fact that Tesla is unique in the auto market, and I respect its ability to disrupt that industry.

While — and circling back to Damodaran’s point — the stock surge it experienced on Monday last week wasn’t grounded in fundamentals, you can’t fight the market either.

So what does an investor do with a stock such as Tesla that continues to soar higher even though its fundamentals don’t back it up?

The prestigious professor’s take was that he doesn’t touch it. It’s not his style to go after these types of stocks, and he knows he leaves cash on the table.

But not everyone has the same investment strategy, and many of you may already own shares in Tesla.

That’s why I want to take a moment today to take another look at Tesla.

Destined for Greatness?

Tesla’s stock soared last week after the company announced that it surpassed expectations by delivering 25,000 cars in the first quarter of the year.

That’s not a huge accomplishment, but it is one of the first times the company has surpassed expectations.

More importantly, the stock’s surge caused the company’s market cap (which is price times shares outstanding) to surpass Ford’s for the first time.

And today, shares have continued to climb. Tesla is now the highest-valued automaker in the United States — pretty impressive.

What does this mean?

Well, it means Tesla is projected to indeed be the leading automaker, despite it being at the bottom of the group at the moment in terms of car sales. It’s priced as if it sold 23 times the amount of cars in the first quarter of the year — because that’s roughly how many cars Ford sold in the U.S.

Analysts at the investment firm Pacific Crest project that Tesla can deliver about 428,000 cars a year by 2020. Ford and General Motors each hit that amount of U.S. sales during the first quarter of this year.

Clearly this is still a huge growth opportunity for Tesla, going from 25,000 cars a quarter to over 100,000 in just a few years. But is that growth already priced in, and what’s the upside potential for the stock? For the answer, let’s take a look at a price chart of Tesla’s stock:

Don’t get me wrong: I’m a big fan of what Tesla has accomplished. But when you have a stock that’s overvalued as much as Tesla is, you want to be careful.

The red horizontal line near the top represents an area of resistance for the stock, where it has faced pressure to retreat and pull back.

But on the news Tesla sold 25,000 cars in the first quarter — nothing outstanding or groundbreaking — shares broke out above that resistance and hit new all-time highs.

Watch Out for a Slip

If you have followed my colleague Paul at all, then you know that a new high is a bullish sign. But when you have a stock that’s overvalued as much as Tesla is, you want to be careful.

So you can buy shares today, or if you already own them, you can feel good about holding them. In other words, don’t sell your shares just yet.

But be cautious and alert to the fact that the stock’s stretched on its valuation. I would place a stop right around the $285 level, and at some point initiate a 30% trailing stop once that stop is above the $285 level.

The $285 price point marks just below the resistance line shown above. This will be the key level going forward, and if the price holds above it, there could be another major rally for the stock.

But if it falls below $285, you will want to get out until the stock can climb back above that level — because the bottom could be another $100 away, near the $180 level.

So if you own Tesla, congratulations on the strong rally, but be prepared to take your profits if the stock slips.


Chad Shoop, CMT
Editor, Automatic Profits Alert