Whether you would or not, a lot of people have chosen to invest in Tesla Motors Inc (NASDAQ:TSLA), and that meant that Tesla’s stock price went way up — even though the company hadn’t yet earned any money.
That was an irresistible situation for many investors, who opened up big short positions on Tesla. And when I say “many investors,” I mean many: As of a few days ago, about 40% of the Tesla shares on the open market had been sold short, according to The Wall Street Journal.
That’s huge. And it set the stage for what happened next.
A textbook “short squeeze” was like rocket fuel for the stock
That big percentage, what we call a high short interest in Tesla, meant that the stock was primed for a short squeeze. That’s what happens when there’s a big positive development on a stock with a high short interest that drives the price up.
When there’s a high short interest on that stock, the price can go up very very quickly. That’s because all those short investors are rushing to buy the stock to cover — close out — their investments before the stock gets even more expensive.
In other words, those short investors get squeezed.
That looks like exactly what happened. Tesla’s stock closed at $55.79 on Wednesday. After that, two things happened:
- Tesla announced a profit. After the market closed on Wednesday, Tesla announced its first-ever quarterly profit. It was small — only $15 million or $0.12 a share excluding some special items — but Wall Street had expected just $0.04 a share. The stock went up big in after-hours trading.
- Consumer Reports threw fuel on the fire. The next morning, Consumer Reports announced that Tesla’s Model S sedan, shown above, had scored 99 out of 100 in its testing. That’s equal to the best cars the magazine has ever tested. That’s a big, big seal of approval for a start-up carmaker, and it added even more fuel to the rocket driving Tesla’s stock price higher.
So even though its price was already high,Tesla’s stock soared on the one-two hit of great news. That probably led many shorts to rush to close their positions, and that in turn drove the stock up even higher: Tesla closed at $69.40 on Thursday. And it kept going: Tesla stock closed at $76.70 on Friday. It might go even higher next week.
But won’t it eventually come down?
Tesla could return to Earth … eventually
Sure, it might. While Tesla has done a very impressive job of executing on its business plan, there’s still a long way to go before it will make enough money to justify anything like its sky-high stock price. And it may never get that far, for two big reasons.
First, electric cars are still a niche market, and that might not change. Tesla might be able to sell enough cars every year to make a profit, but it might be a small profit that only justifies a share price of $10, not $70.
Second, if electric cars do start to get popular, there are massive competitors waiting to step in: all of the world’s big automakers. They all have research resources and economies of scale that absolutely dwarf anything Tesla will be able to muster. How Tesla will survive and thrive when it’s competing against the big automakers is an open question, and a daunting one.
All of that could drive the stock down in time. Probably will, say some analysts.
But there’s an old saying among stock traders: The market can stay irrational longer than you can stay solvent. Short sellers who are making big interest payments may not be able to afford to hang on until Tesla’s price falls — if it ever does.
Long story short (so to speak), they’re getting burned. If you own Tesla stock, enjoy the ride.
The article Why These Tesla Investors Got Burned originally appeared on Fool.com.
Fool contributor John Rosevear owns shares of Ford. Follow him on Twitter at @jrosevear. The Motley Fool recommends and owns shares of Ford and Tesla Motors.
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