Tesla Stock Is a Falling Knife As the Laws of Gravity Finally Get Working

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Mar. 4 2021, Updated 9:54 a.m. ET

Tesla stock, which gained 740 percent in 2020, has looked weak in 2021. It's now down 27 percent from its 52-week high. After the crash in Tesla stock, many investors who missed the rally or sold the stock too early are wondering if they should buy TSLA now.

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While Sir Isaac Newton put forward his laws of gravity in 1687, John Bogle later expanded it to stock markets, arguing that returns from stocks and mutual funds mimic broader markets in the long term. Similarly, technical analysts' gravity theory states that assets move toward their mean values. There's also the rule stating that stocks that rise quickly also fall quickly. 

So, which of these laws is at play in Tesla stock? I would say all three.

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why is tesla stock falling
Source: Koyfin

Tesla and other EV stocks have fallen

Why is Tesla stock falling?

We shouldn't single out Tesla. If anything, it's fallen less than other EV (electric vehicle) stocks, such as NIO, XPeng, and Li Auto. With that in mind, however, we should ask whether Tesla stock is falling because of the sell-off in EV stocks, or vice versa.

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is tesla stock overvalued
Source: Koyfin

EV stocks are trading at a massive premium

Is Tesla stock overvalued?

As we saw when Lucid Motors announced its merger with Churchill Capital IV (CCIV), Tesla stock is EV companies' valuation benchmark. To purists like Ashwath Damodaran, however, Tesla stock will always look overvalued. Even after the recent crash, Tesla’s market capitalization is triple that of the next most valuable automaker, Toyota Motors.

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But is Tesla even an automotive company? As an automaker alone, it can't justify its current valuation. And Tesla CEO Elon Musk seems to know that—he tried to use the company's mobility business to justify the soaring valuation, stating that it was the real long-term earnings driver.

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Tesla and carbon credits

To arrive at Tesla’s valuation, we need to consider several factors. As automakers expand their EV operations, they'll need fewer carbon credits. If we remove carbon credits, Tesla’s GAAP profit (only about 1 percent over the last 12 months) would turn into a loss.

And that’s not all. As automakers scale up, there will be a flurry of new, all-electric models, triggering a price war as we've seen in China. This would mean narrow profit margins and returns for Tesla and other EV companies. 

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Are the laws of gravity at play?

Tesla stock ballooned in Oct. 2019 when the company posted a surprise profit. The number of investors looking to buy the stock at every dip grew to an army, and Musk, using his marketing magic, announced a stock split in 2020 after TSLA became too costly for some.

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But in 2021, the laws of gravity have come into play. Whereas Tesla and other EV stocks have come off their highs, legacy automaker stocks Ford and General Motors have risen (though their valuations are still nowhere near Tesla's).

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Should I buy Tesla stock now?

Tesla stock is built on belief in the company and Musk. To his credit, Musk has defied all pessimism and made Tesla thrive. The company delivered almost half a million cars in 2020, and now even has ample cash to buy bitcoin.

If you believe in Musk’s vision of disruption, Tesla stock could offer value. However, if you think that legacy automakers will be able to compete in the EV space, Tesla may look overvalued.

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I think legacy expect Tesla stock to fall more and expect legacy automakers to put a good fight. At the cost of attracting the wrath of Tesla bulls, I would call it a falling knife and advice staying away for now. After a strong 2020, 2021 looks like the year of reckoning for EV stocks as markets finally question the soaring valuations.

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