Options Market Still Has A Bearish Outlook For Tesla

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TSLA shares enjoyed a meteoric rise in late 2021, reaching an all-time high closing price of $1229.91 on November 4, 2021. Since then, however, the shares have been in a downward trend and are currently at $640.60, 48% below the November high.

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12-Month price history and basic statistics for TSLA (Source: Seeking Alpha)

There have been many factors that have contributed to the decline in the shares. First and foremost, the valuation was absurd by late 2021. The Cathie Wood “never bet against disruptive innovation” meme led many investors to disregard concerns like earnings growth. Second, rising interest rates are a headwind for stocks with valuations that depend on earnings far into the future. The discount rate used to calculate net present value of those future earnings rises with interest rates, and distant earnings make the valuation calculation very sensitive to the discount factor. The broad market conditions have shifted and investors are now far more skeptical of growth stocks with sky-high valuations.

ETrade

Trailing and estimated future quarterly EPS for TSLA. Green (red) values are amounts by which EPS beat (missed) the consensus expected value (Source: ETrade)

It must be noted that TSLA’s earnings growth has been very impressive in the past several years, and the Q1 results, reported on April 20th, were 42.5% above the consensus expected value. TSLA sold almost 940,000 cars in 2021, almost double the number in 2020. The problem, of course, is that even with this spectacular growth and the drop in share prices, TSLA’s valuation continues to be extremely high by any measure. With a TTM P/E of 91 and forward P/E of 54, TSLA is very expensive for a tech company and is astronomical for a car company. I am not suggesting comparing TSLA to a company like Ford (F) or Toyota (TM), of course, because TSLA is an innovation-first engineering leader, without a legacy business in traditional gas-powered cars. Even a company with phenomenal growth prospects has some price that is too high, however. The question is whether TSLA is within the range of a justifiable valuation.

I last wrote about TSLA on April 15, 2021, about 13 months ago, and I assigned a sell/bearish rating. The basis for my rating was straightforward. The valuation was exceedingly high (forward P/E of 180), the valuation was obviously going to be hurt by rising interest rates, and the Wall Street consensus outlook was neutral, with a 12-month price target slightly below the share price at that time. In addition, the market-implied outlook, which reflects the consensus view from the options market, was bearish with very high volatility. In the period since TSLA rose to almost $1,230 before falling to the current price of about $640.

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Previous analysis and subsequent performance for TSLA vs. the S&P 500 (Source: Seeking Alpha)

The price of an option on a stock reflects the market’s estimate of the probability that the share price will rise above (call option) or fall below (put option) a specific level (the option strike price) between now and when the option expires. By analyzing the prices of call and put options at a range of strike prices, all with the same expiration date, it is possible to calculate a probabilistic price forecast that reconciles all of the options prices. This is the market-implied outlook (for a deep dive into the theory, see this paper). One of the benefits of looking at the market-implied outlook is that it reveals a rich view on investor expectations. Specifically, the market-implied outlook provides insight into the types of outcomes that investors are betting on. For TSLA, as with many other high-growth stocks, the expected distribution of outcomes was positively skewed, meaning that there was a high probability of losing money by owning TSLA and a small probability of large gains. Research confirms that stocks with this attribute in the market-implied outlook tend to underperform.

Today, TSLA’s valuation is much lower than it was a year ago but is still very high (forward P/E of 54 and TTM P/E of 91). I have calculated an updated market-implied outlook for TSLA, for the 7.9-month period to January 20, 2023, and I compare this with the current Wall Street consensus outlook in revisiting my rating.

Wall Street Consensus Outlook for TSLA

ETrade calculates the Wall Street consensus by aggregating the views of 29 ranked analysts who have published ratings and price targets over the past 3 months. The consensus rating is bullish (vs. neutral when I last wrote about TSLA) and the consensus 12-month price target is 48% above the current share price. A significant red flag in looking at this outlook is the high level of dispersion among the individual price targets. When this spread is high, research has found a negative correlation between the return implied by the consensus and the subsequent realized returns (so this consensus outlook would actually be a bearish indicator).

ETrade

Wall Street analyst consensus rating and 12-month price target for TSLA (Source: ETrade)

Seeking Alpha’s version of the Wall Street consensus outlook is calculated using ratings and price targets from 38 analysts who have published their views over the past 90 days. The consensus rating is bullish and the consensus 12-month price target is $953.33, 50% above the current share price. As in the ETrade results, the spread among the individual price targets is very large.

Seeking Alpha

Wall Street analyst consensus rating and 12-month price target for TSLA (Source: Seeking Alpha)

As a rule of thumb, I strongly discount the consensus price target when the highest individual price target is more than twice the lowest. Even throwing out some of the very highest and lowest price targets for TSLA, this ratio is much higher than 2X.

Market-Implied Outlook for TSLA

I have calculated the market-implied outlook for TSLA for the 7.9-month period from now until January 20, 2023, using the prices of call and put options that expire on this date. I selected this specific expiration date to provide a view through the end of the year and because the options expiring in January tend to be among the most actively traded, adding confidence in the representativeness of the outlook.

The standard presentation of the market-implied outlook is a probability distribution of price return, with probability on the vertical axis and return on the horizontal.

Geoff Considine

Market-implied price return probabilities for TSLA for the 7.9-month period from now until January 20, 2023 (Source: Author’s calculations options quotes from ETrade)

The market-implied outlook to January 20, 2023 is significantly positively skewed and the maximum probabilities are significantly tilted to favor negative returns over this period. The maximum-probability outcome corresponds to a price return of -35%. This is a very bearish outlook. There is also a significant secondary peak corresponding to a price return of -100%, but extremely large outcomes are not reliably estimated (see page 37) by market-implied outlooks. This secondary peak shows that far out-of-the-money put options are very expensive, but one cannot realistically use this to estimate default risk.

The expected volatility calculated from this outlook is 74% (annualized), which is very close to the 73% implied volatility that ETrade calculates for these options.

To make it easier to directly compare the relative probabilities of positive and negative returns, I rotate the negative return side of the distribution about the vertical axis (see chart below).

Geoff Considine

Market-implied price return probabilities for TSLA for the 7.9-month period from now until January 20, 2023 (Source: Author’s calculations options quotes from ETrade)

This view clearly illustrates that the probabilities of negative returns are consistently and substantially higher than the probabilities of negative returns of the same magnitude, across a wide range of the most-probable outcomes (the dashed red line is significantly above the solid blue like across most of the chart above). There is, however, a long tail of large-magnitude positive returns. This market-implied outlook is qualitatively similar to my results from April of 2021.

While theory suggests that the market-implied outlook is expected to have a negative bias, there is no way to directly measure whether this effect is present. This market-implied outlook is sufficiently negative, as compared to the wide range of other cases that I have run, that I am comfortable interpreting this market-implied outlook as substantially bearish.

Summary

Tesla is a remarkable company that has dramatically accelerated and grown the market for electric vehicles. Investors’ enthusiasm for the company, along with the throngs of those who hang on Elon Musk’s every tweet (he has more than 90 million followers), has allowed the share price to decouple from fundamentals for a number of years. The declines since November suggest that the market may have become more discriminating, but the valuation remains very high. The Wall Street consensus outlook has shifted from neutral to bullish in recent months, and the consensus 12-month price target is about 50% higher than the current share price. That said, the extremely high dispersion in the individual price targets leads to me largely discount this bullish view. The market-implied outlook for TSLA to early 2023 is very bearish, with high volatility. I am maintaining my bearish/sell rating on TSLA.