Don't Confuse Companies with Stocks

Don't Confuse Companies with Stocks

Posted on January 22, 2020

Market State 1 – Bullish: The market, as measured by the S&P 500, remains in a bullish Market State 1.  Most new market highs occur while in Market State 1.  Of the 1,249 new market highs since October 1950, 1074 of them have occurred while in MS 1 (86%).  All other new market highs have occurred in other bullish Market States, with just 19 of them occurring during a transitional Market State 6.

Canterbury Volatility Index (CVI)- CVI 45: Volatility, as measured by the Canterbury Volatility Index, is currently at extreme low levels.  Extreme low volatility may be subject to a spike resulting in an outlier day (+/-1.50%).  On the other hand, low volatility is still a bullish market characteristic, whereas high or increasing volatility is a transitional/bearish characteristic.

It seems like just about every other week Elon Musk and his company, Tesla Motors, are in the news for one reason or another.  In fact, the company’s stock has seen a huge surge price to begin 2020.  Since Tesla’s initial public offering (IPO) in June of 2010, the company’s stock has been one of the hottest for the last decade, rising from $17 at its IPO, to Friday’s close of $510 (+2,900%!).  Based on this information, one might believe Tesla to be one of the most innovative and profitable companies out there. 

Innovative? Definitely. There is no question Tesla’s all electric car shook the auto industry and pushed more companies into the electric vehicle market. But is Tesla a profitable company?  Far from it.
Tesla’s net earnings for the last few years have been… less than ideal.  In fact, the company has been far from turning a profit.  Since the year Tesla went public (2010), Tesla has failed to report net positive year-over-year earnings.  That’s 10 consecutive years of negative earnings.  Take a look at just the last 3 reported years (through the end of 2018 since 2019 has not been fully reported yet):
Year Net Revenue (Loss) in Millions
2016 ($675)
2017 ($1,900)
2018 ($976)
Source: Tesla 10k SEC filings

From 2016 through 2018, Tesla as a company lost over 3.5 BILLION dollars.  Through the first 3 quarters of 2019, the company has reported net losses of ($967 million).  So, for a company that has reported losses of nearly 4.5 billion dollars over the last 4 years, its stock is up 114%.

Let’s compare that to other auto manufacturers like Ford and General Motors, who have profited money every single year since 2011 (Tesla’s first full year as a stock):
Company 2018 Worldwide Units Sold 2018 Net Revenues (loss)
Ford 5.3 million units $3.7 Billion
GM 8.5 million units $7.9 Billion
Tesla 350,000 units (2019: 367,000) ($976 Million)
Source: Company 10k SEC filings

Now here are their average stock returns from 2011-Present (Friday, Jan 17, 2020):
Year Ford GM Tesla
Average Yearly Return -2.66% +2.45% +38.72%
Growth of $10,000 $12,450 $7,830 $193,259

So, while Ford and GM each profited several billion for 2018, and have every year since 2011, Tesla, which has lost money every year, saw its stock value increase dramatically.
Now, here is the real shocker…

Tesla’s market capitalization (company equity value equal to shares outstanding multiplied by price) is larger than Ford and General Motors COMBINED. 

That’s right. A company that has reported several billion dollars in negative revenues and sold a small fraction of the amount of cars, is larger than auto giants GM and Ford combined. So, the question is: are stocks and companies the same?

Companies are driven by profits and earnings.  When you own a company, your earnings are dependent on the company’s profits.  If the company makes money, you make money.  If the company loses money, you’ll have to put more money into it.

Stocks, on the other hand, are driven by law of SUPPLY and DEMAND and investors’ beliefs about the future.  If the demand for a stock is greater than the supply, the price will increase.  If supply is greater than demand, the stock will decrease in value.

Owning a company and owning a stock are two completely separate animals. Company fundamentals are, at best, a lagging indicator.  Just because a company like Tesla loses money every year, does not mean its stock won’t stop going up.  In fact, Tesla could make money this year, and its stock might go down. It all depends on supply and demand.

The Importance of Compounding
One quick, interesting note to point out is how Tesla’s market capitalization became larger than Ford and GM combined. This was primarily due to the benefits of compounding.  If we go back to the $10,000 investment example, that investment in 2011 would have grown to $193,000 today.  We also mentioned that in the last 4 years, Tesla’s stock price has doubled.  So, the $10,000 investment would have grown to $100,000 by the end of 2015, and then doubled over the next 4 years to get to roughly $200,000.

In order for $10,000 to grow to $100,000, Tesla’s stock would have had to double a little over 3 times ($10,000à$20,000à$40,000à$80,000à$100,000).  Each time the stock doubled in value, the investment was coming off of a larger base. Meaning, that it took $10,000 doubling more than 3 times to get to $100,000, but only had to double one more time to turn into $200,000.  That is how Tesla’s market capitalization became so large: the benefit of compounded returns.

Bottom Line
The advantage of owning a stock is the liquidity.  Today, we have the ability to buy and sell stocks instantaneously at very little cost.  Yet, most investors practice a buy and hold philosophy.  They take the advantage of owning liquid securities, and neglect to use it.  Markets assume that we know the difference between a bull and a bear market, just like a private business owner should know the difference between a good company and a bad company. 

In order to navigate ever-changing market environments, we have to adapt our investment portfolios, and take advantage of liquidity. Buying and holding a fixed allocation will only subject the portfolio to volatile bear markets and large drawdowns.  Large drawdowns are what we don’t want, because they limit our ability to compound returns. Every drop in our portfolio value requires a larger return to get back to breakeven.  We want to limit our drawdowns, by avoiding bear markets so that we can achieve the benefits of compounding.