Is it Time to Short Tesla Stock ? (NASDAQ: TSLA)

Tesla (NASDAQ: TSLA) shares have raced ahead more than 250% year-to-date trailing only Zoom Video Communications (up 261%) among Nasdaq 100 constituents. While the move in Zoom stock makes intuitive sense given its connection to the pandemic economy, Tesla's surge is harder to accept.

After all, we are in a recessionary economy with improving but still rampant unemployment and constrained consumer budgets with less room for pricey electric vehicles.

Tesla delivered an outstanding first-quarter report that included a 38% jump in automotive sales and profits that trounced the Street's expectation of a small loss. The recent momentum and growth prospects certainly suggest an upward trending share price is justified.

But with a market cap of $280 billion, the cart is now ahead of the horse(power). Today Tesla has a higher market value than legacy companies such as Pepsi, Home Depot, Intel, Disney, and AT&T. Leapfrogging just a couple more companies will put among the top 10 highest valued U.S. corporations.

Rising competition, shrinking margins

Tesla has been announcing price cuts on various vehicle models to the delight of both car buyers and investors. But it begs the question -- are cuts occurring because the economies of scale support or is Tesla feeling the heat of rising competition from not only traditional auto manufacturers but ambitious upstarts?

Major automakers like Ford, General Motors, and Honda have all ramped their electric and hybrid vehicle programs in recognition of the industry's low carbon future of the industry. BMW, Fiat Chrysler, Nissan, Kia, and Volkswagen and several more have joined a growing list of car companies getting into the electric game. Not to mention new entrants like China's NIO which has soared along with Tesla and the rest of the EV pure-play stocks.

There is room for more than winner in the electric vehicle space, but surely all these companies will not achieve the high growth that the market has priced into them. Tesla is now attempting to be in all areas of the auto market from luxury to economy, but whether it can maximize its opportunity and profits by being everything to everyone remains to be seen. It has a first mover's advantage and a reputation for superior technology and software, but consumers now have more choice than ever when it comes to electric vehicles.

This leads to a discussion of Tesla's profitability. While it has come a long way in recent years and is on the cusp of achieving a sustainably green bottom line, gross margins have been moving in the opposite direction of the share price. Gross margin was as high as 29.6% in 2014, 27.7% in 2016, 22.3% in 2018, and is 20.6% today. Ideally, investors would like to see expanding gross margins accompany a company's rise to profitability.

And while Tesla's overall financial health has improved, it still has a substantial long-term debt burden. It has $10.7 billion of long-term debt on its books which represent 117% of shareholders' equity. Many investors consider anything above the 100% mark to be a warning sign of deteriorating financial health. This along with the declining gross margin suggests there is a disconnect between the stock's atmospheric climb and its fundamentals.

Technical indicators point to overheated conditions

From a technical analysis perspective, Tesla's share price has climbed approximately 58% above its 50-day moving average of $978. For a stock that had been humming along this support line since regaining it in mid-April, the sudden departure has been extraordinary.

Back on February 4^th Tesla jumped to $968 leaving its 50-day moving average in the dust by over 100%. By the end of the month, sellers took control and the stock was back at the 50-day trend line at $667 for correction of about 30%.

A correction of a similar magnitude appears to be in order here. Aside from the simple moving average, several other technical indicators are pointing to overbought conditions in Tesla. The relative strength, Bollinger band, and MACD indicators suggest the engine is overheated and a near-term pullback is imminent.

Of course, the counter-argument here is that Tesla's five-year return is around 15% compared to 10% for the S&P. Given the superior growth metrics and outlook, this return would seem reasonable if not suggest there is ample room for Tesla to further distance itself from the broader market. It very well may do this over the long haul, but not before taking several steps back to reality.

The Musk Factor

Of course, one cannot mention Tesla without a comment on its fearless leader Elon Musk who is as volatile as his company's stock. The man while undeniably brilliant and forward-thinking is a loose cannon.

His antics on social media threatening to operate or even relocate Tesla's California factory in the face of COVID-19 restrictions demonstrated not only a self-indulged disdain for the safety of his employees and the surrounding community but the volatility of his leadership style. How will the next crisis be managed?

While some investors surely enjoy if not thrive on the Tesla drama, others would prefer to avoid companies that are prone to erratic, knee-jerk posturing, and decision making. It just doesn't bode well for the potential impact on business performance.

Investors will recall that in August 2018 Musk toyed with the idea of taking the company private back in when the stock was trading at $420 per share. Not following through on that 'threat' has worked out well. Several lawsuits and executive departures later, the stock is worth nearly 4-times more. It makes you wonder if it was all part of the dramatic theater that is Tesla.

High voltage expectations heading into Q2 earnings

With this said, even some of the most skeptical bears would support the notion that Tesla will emerge as a long-term winner in its quest to revolutionize the global automotive industry. It's hard not to see that happening.

But in the near-term, a reckoning of the share price is in order both from technical and fundamental standpoints. Elevated leverage and declining margins are of particular concern.

Much of the recent rally in Tesla shares have been driven by the anticipation of another blowout quarter when the company reports second-quarter results on July 22^nd. Expectations are sky-high. The slightest shortfall or even a more modest than expected outperformance has the potential to put the stock in reverse.

Barring a huge Q2 surprise, irrational exuberance, or some other unexpected near-term catalyst, the $1794.99 peak of July 13^th may be the highest we see the stock for a while.