April 27, 2016

Sell The News: Why a Great Model 3 Launch is Bad News For Tesla Stock

by Richard Peterson

Co-author, Sean Reilly, MarketPsych Research Intern

Overview

Deposits for the Model exceeded 400,000 as of April 19th, yet Tesla stock sagged from its peak. A pattern of stock price appreciation before a widely publicized launch event (TSLA is up 73% from its February 10th low) is often followed by a decline in stock price after the event.  Stocks such as Apple experience such events, with the Wall Street Journal describing this pattern in Apple’s stock price as early as 2002.  This “buy on the rumor, sell on the news” price pattern has been documented in academic research on stock prices, and it follows a predictable course around highly anticipated IPOs and earnings announcements as well as around highly anticipated product launches such as those for emotionally-appealing companies including Apple, Pixar, and Tesla. Stocks with specific characteristics – described below – appear most vulnerable.  In this article we describe how investor sentiment around Tesla appears predictive of the stock price and suggest how the stock price is vulnerable to a downshift in investor sentiment going forward.

Sentiment Analysis

Tesla’s products and mission are psychologically compelling. The beauty and sophistication of the products, the visionary leadership, the idea of feeling and looking good while doing good – these are profoundly important selling points for the company. But how do we value such sentiments? And if they could be valued, what risks might they pose?

Investor sentiment about Tesla is quantified from both news and social media by sentiment analytics firm MarketPsych in collaboration with Thomson Reuters through the Thomson Reuters MarketPsych Indices (TRMI). The TRMI sentiment index for Tesla represents the net frequency of all positive versus negative sentiment posts in the media.

In the following plot of Tesla’s sentiment from July 2014 to April 2016, the stock price is plotted alongside the 30 and 200 day averages of Tesla media sentiment. Between the two moving sentiment averages, green shading indicates that short term sentient is rising over longer term (media towards Tesla is trending positive), while pink shading represents and shorter term bearish tone. Read more about sentiment-driven price patterns in our book Trading on Sentiment: The Power of Minds over Markets (Wiley, 2016), a book about capitalizing on investors’ collective misbehaviors.

Tesla 1

A pattern appears in the chart. In a period of just under two years, the sentiment has not only tracked, but even correctly predicted the short term tops for the stock price. In both of the historical cases, the sentiment spikes were followed by sentiment (and stock price) declines. Today, the chart is showing a decline off the most recent sentiment peak.

Buy The Rumor, Sell The News

We evaluated the psychological state of Tesla investors against a set of “Buy on the Rumor” criterion published in academic research.[i],[ii]  Tesla fulfilled many, if not all of the signals of being at a short-term optimistic peak:

  1. Positive sentiment : The Model 3 was touted to be a revolutionary car- the first affordable, luxury, and completely electric vehicle..
  2. Vividness: Tesla’s products are beautiful machines – the perfect combination of form and function. Not unlike Apple’s frenzy-inducing products.
  3. Confirmation: In the 2 months before the launch Tesla’s price rose over 60%.
  4. Authority: Elon Musk’s visionary leadership motivates buying. And on April 6th (the most recent price peak) he said it was “probably unwise” to short the stock.
  5. Huge potential: The 400,000 preorders are substantial. And much about Tesla is BIG – think “gigafactory.”
  6. Lack of specifics: There is insufficient information available to use typical valuation metrics. With a forward P/E of 71.20 and a debt to equity ratio of 2.49, Tesla’s valuation is based on expectations of future growth. Musk is unclear about delivery dates, locations, and costs. If setbacks ensue and investors start to lose faith, there is little underlying support for the stock price.

Such criteria for a frenzy set the stock up for a post-launch fall. We are now in the unravelling phase, and this can last for several months as the stock settles back to earth.

Investors are starting to get off the bandwagon now that the news has run its course.

Conclusion

Given the hype around the Model 3 launch (reminiscent of a buy on the rumor and sell on the news pattern), the fundamentals built on investor expectations, and the clear downtick in overall sentiment about the company (off a recent peak), over the next 3 months (at least) Tesla’s stock price is likely to underperform.

[i] Peterson R. (2005). “Buy on the Rumor and Sell on the News.” Chapter 30 of the textbook Risk Management, Else-vier Publishing.
[ii] Peterson, R. (2002). “‘Buy on the Rumor:’ Anticipatory affect and investor behavior.” Journal of Psychology and Financial Markets, v3, n4. html.

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