Looking at the Magnificent 7

The "Magnificent 7" companies have replaced the "FAANG" stocks, which means that Netflix has been dropped from the growthy-tech investor zeitgeist and Microsoft, Nvidia, and Tesla have been added. The combined market capitalization of the Mag 7 is $14 trillion, which is equal to one-third of the total market capitalization of the S&P 500 companies ($43 trillion). 

That is a very high level of concentration in the top index picks, which means that the returns for the float adjusted, market capitalization weighted index that most index investors buy (SPY) will likely be meaningfully different than the returns on the equally weighted index (e.g. RSP). (The equal weight RSP is trading for 19x earnings versus 21.5x for the SPY.)

Since we are generalists at CBS, it is "our business to know" what is going on with everything, even the frothy Magnificent 7. I thought that we should take a look at the cash generation power of these businesses. What do you get for $14 trillion? How are the free cash flow conversion margins - are these actually good businesses - and what is the valuation (FCF/EV)?

Before I did that, I wrote down my subjective view of business quality or moat for each, on a one to five scale. I am a customer of five of the seven (i.e. all of them except Nvidia and Tesla). How hard would it be for me to fire them? How hard do I think it would be for a team of well-funded 10x engineers to disrupt them? 

Based on that framework, I think that Tesla is 1/5; clearly the worst. (It now has the smallest market capitalization by a significant margin, while it was once larger than Facebook.) I think that Apple is clearly the best, 5/5. I gave Nvidia 4/5 although I am not very familiar with the company or its products. I think that Microsoft, Amazon, and Google are 3s and Facebook is a 2. (Without Instagram, Facebook would be a 1.)

How did my subjective view line up with the numbers? Surprisingly well. Click the table below to enlarge:

Some observations that stand out:

Microsoft blew an entire quarter's revenue, $65 billion, on the acquisition of Activision. But even adding that back, Apple generated almost as much free cash flow ($34.5 billion) as the other six companies combined ($46 billion).

Apple has the second highest free cash flow margin (29% of revenue) of the Mag 7. Nvidia's was 46%, a tobacco-like margin. We know that Amazon is a low margin retail business, Tesla is a joke of course, but Microsoft and Google have very lackluster free cash flow conversion.

Google's stock based compensation (SBC) in the most recent quarter was equal to 30% of cash from operations, and capital expenditures were equal to 58% of cash from operations. (Or 6% of revenue and 9% of revenue, respectively, if you want to look at it that way.)

Apple spent only 8% of cash from operations on SBC in the most recent quarter (3% of revenue), and only 6% of CFO on capital expenditure (2% of revenue), leaving much more free cash flow.

We know that Google is an inferior business to Apple because Google pays a gigantic tithe to Apple. But notice that Apple's most recent quarter cash flow was running at a 5% yield on the enterprise value. That is much more attractive than the other companies in the Mag 7 (which otherwise seem quite expensive).

Apple seems to have the best combination of moat and valuation. If you had to own one of the Mag 7, Apple would be our choice, hands-down, based on business quality and valuation. (Maybe you do have to own one. How far from the S&P 500 index and its performance are you allowed to stray?)

Berkshire has $156 billion of Apple stock, just over a quarter of its own market capitalization. We do not like Buffett's energy pick, but we do like his tech pick.

Matsko v. Tesla, Inc. dba Tesla Motors, Inc. et al

A class action lawsuit was just filed against Tesla in federal court in Northern California by a customer who paid for "autopilot" but has never received a truly self-driving car:

Plaintiff brings this consumer class action lawsuit to hold Tesla and its representatives, including CEO Elon Musk, accountable for years of making misleading and deceptive statements regarding the company’s advanced driver assistance systems (“ADAS”) technology. For years, Tesla has deceptively and misleadingly marketed its ADAS technology as autonomous driving technology under various names, including “Autopilot,” “Enhanced Autopilot,” and “Full Self-Driving Capability” (“FSD”), the latter two of which Tesla charges consumers thousands of additional dollars to add to their new vehicle. Tesla has deceived and misled consumers regarding the current abilities of its ADAS technology and by representing that it was perpetually on the cusp of perfecting that technology and finally fulfilling its promise of producing a fully self-driving car. Although these promises have proven false time and time again, Tesla and Musk have continued making them to generate media attention, to deceive consumers into believing it has unrivaled cutting-edge technology, and to establish itself as a leading player in the fast-growing electric vehicle market.

Despite portraying itself as a leader in autonomous vehicle technology, Tesla’s ADAS features have been surpassed by numerous automaker competitors that have developed autonomous driving technology far more advanced than Tesla’s, and now available in some consumer markets. At the same time, former Tesla employees and investigations have revealed damning information that now makes clear that, contrary to Tesla’s repeated promises that it would have a fully self-driving car within months or a year, Tesla has never been remotely close to achieving that goal.

For example, to accompany the 2016 launch of Tesla’s “Enhanced Autopilot” and “Full Self-Driving” versions of its ADAS technology, much of the Tesla Autopilot engineering team dropped everything to produce a video that purports to show a Tesla car driving itself. The video begins with the following message: “The person in the driver’s seat is only there for legal reasons. He is not driving anything. The car is driving itself.” In reality, Tesla employees made the video would later reveal that the car in the video had significant assistance from commercial mapping software not available to Tesla customers, and that the car still performed poorly and even ran into a fence during filming. With the assistance of a large team of Tesla engineers, the car had to run the same route over and over again before Tesla got acceptable video that appeared to show a car capable of driving itself. Even though the video was debunked as deceptive and misleading years ago, Tesla continues to prominently feature it on its website.

Six years later in 2022, Tesla has yet to produce anything even remotely approaching a fully self-driving car. Instead, Tesla pushes out “updates” to its experimental FSD Beta software to a small minority of Tesla owners, who effectively act as untrained test engineers testing experimental software on public roadways. Drivers have consistently found that Tesla’s FSD Beta software has myriad problems, such as cars failing to make routine turns, running red lights, and steering directly into large objects and oncoming traffic. There have also been numerous collisions involving Tesla’s purportedly cutting-edge ADAS software, including Tesla vehicles plowing at high speeds into large stationary objects such as emergency vehicles and an overturned box truck. Dozens of people have suffered fatal and other serious injuries as a result of these ADAS-related collisions, triggering a host of investigations by state and federal regulators.

As information has trickled out of the secretive company via former employees and investigations, it has become increasingly clear that Tesla knew for years its statements regarding its ADAS technology were deceptive and misleading, but the company made them anyway. Tesla did so to generate excitement about the company’s vehicles and thereby improve its financial condition by, among other things, attracting investment, increasing sales, avoiding bankruptcy, driving up Tesla’s stock price, and helping to establish Tesla as a dominant player in the electric vehicle market.

[...]

Plaintiff brings this class action lawsuit on behalf of himself and fellow consumers who purchased or leased a new Tesla vehicle with Tesla’s ADAS technology but never received the selfdriving car that Tesla promised them. Plaintiff brings claims against Tesla for violations of the federal Magnuson-Moss Warranty Act and California’s False Advertising Law, Consumer Legal Remedies Act, and Unfair Competition Law, as well as common law claims for fraud and deceit, negligent misrepresentation, negligence, and unjust enrichment. Plaintiff seeks various relief on behalf of himself and the proposed Class, including injunctive relief prohibiting Tesla from continuing its deceptive and misleading marketing of its ADAS technology, restitution of the money Plaintiff and Class members paid for technology that Tesla promised but never delivered, and all available damages including punitive damages to punish Tesla for years of using deceptive and misleading marketing to eventually establish itself as a dominant player in the electric vehicle market.

Royal Gold, Inc. (RGLD)

We mentioned Royal Gold in our post last October, What I Would Buy Instead of Tesla

Royal Gold (RGLD) for $7.9 billion. A great business model - streaming/royalty interests on gold mines with no debt. Net income of $200 million for the past year is expensive, but it could/should grow as more mines come into production. (They have interests in 41 producing mines and 16 in development, plus more in the pipeline.) They do about 1 transaction a year but it's lumpy - they did none from 2006-2008 or from 2016-2018.

The shares are down subsequently and the market capitalization is now $6.9 billion. The company has no net debt, so the enterprise value is the same or less. Streaming and royalty revenue was up significantly in Q3 2021 vs Q3 2020, even with lower gold and silver prices:

For the quarter ended September 30, 2021, we recognized total revenue of $174.4 million, comprised of stream revenue of $115.9 million and royalty revenue of $58.5 million at an average gold price of $1,790 per ounce, an average silver price of $24.36 per ounce and an average copper price of $4.25 per pound. This is compared to total revenue of $146.9 million for the three months ended September 30, 2020, comprised of stream revenue of $106.5 million and royalty revenue of $40.4 million, at an average gold price of $1,909 per ounce, an average silver price of $24.26 per ounce and an average copper price of $2.96 per pound.

If you annualize the quarterly operating cash flow of $130 million, that's $520 million, a 7.5% cash flow yield on the enterprise value. From the Q3 conference call:

We also had record volume of 97,400 gold equivalent ounces, or GEOs, which was a 27% increase over the prior year period. As metal prices are mixed, most of the increase in our revenue was driven by strong operating performances, as Mark mentioned in his remarks.

It is strange that cryptocurrencies are doing so well and gold is doing so poorly. It is also strange that the unprofitable Robinhood bubble basket keeps rising, from $1.6 trillion of combined market capitalization last year to $2.2 trillion today. For the same price as that basket, you could own:

• All three of the Canadian oil majors, $113 billion
• The entire tobacco industry (PM, MO, BTI, TPB, SWMAY, IMBBY, JAPAY), $380 billion
• A huge proportion of the North American pipeline industry; all of the top ten holdings of the Tortoise Midstream CEF (ENB, MMP, EPD, WMB, MPLX, ET, KMI, TGRP, OKE, DCP, WES) for $334 billion.
• The better part of the world auto industry (TM, Subaru, VW, F, GM) for $578 billion.
• Berkshire Hathaway for $650 billion.
• With the remaining $150 billion you could buy most of the gold mining industry (NEM, GOLD, FNV, SBSW, RGLD, GFI, AU, KGC) for $150 billion.
  

That is $2.2 trillion in combined market capitalization, the same as the 19 Robinhood stocks. Most of the mispricing of the Robinhood basket is coming from Tesla ($1.3 trillion), but there is a significant amount of market capitalization ($320 billion) in Zoom, Uber, Doordash, Carvana, Peloton, Beyond Meat, and Nikola, which are very poor quality, overvalued businesses.

A bubble in poor quality hype businesses and 13,000 gambling tokens while at the same time entire industries that return cash to shareholders are being neglected is evidence to support Lyall Taylor's redemption and liquidity flywheel hypothesis [See: 1, 2]. The very end of a secular trend in growth vs value is a crescendo of selling in some areas (that creates the "value") and buying in the other areas (momentum ones, which become very overvalued)!

Two Updates

Guest Post by "Louisiana" on Meme Stonks

[This guest post is by our correspondent from Louisiana, who previously wrote "Modern Art is a Giant Tax Scam", and "Time to Assess Practical Risk" about coronavirus. He was the winner of the 2018 CBS Prediction Contest.]

In my ongoing conversations with CBS, I've floated a thesis that explains the "value" behind meme stonks from Gamestop to Tesla. I live near Houston but visit family in Louisiana often. The small city of Lake Charles, just across the border, has two major industries: petrochemicals and casinos. The Texas Republican Party is too strait-laced to allow gambling in the state, so more morally flexible Louisiana gladly fleeces Texans on the weekends at remarkably nice casino resorts just two and a half hours from Houston.

From an Austrian subjective value perspective, obviously the casinos must provide some value to their patrons. The value is the manipulation of endogenous neurotransmitters through engagement in artificial addictive behavior, akin to junk food, pornography, or even our beloved nicotine. My thesis is that advances in gamification through mobile-friendly brokerage services like RobinHood, in addition to the obscuring of commissions and the ability to buy partial shares, have made certain parts of the stock market function exactly like a casino. Cryptocurrency is even better for this purpose.

From the gambler's perspective, the ideal stonk or crypto would have certain qualities:

1. High volatility. Gamblers get excited by low-probability but high return outcomes. The perception is even better than this, however. The historical growth of these issues makes the risk seem minimal compared to blackjack. One way to conceptualize these stocks is like the Powerball lottery. The more tickets that are sold, and the longer the jackpot goes unclaimed, the larger the prize becomes. Imagine the appeal of Powerball if tickets never expired until the prize was awarded. Either way, earning an inflation-proof 7% in Altria or oil royalties for 20 years is not on the menu.

2. Like smokers, alcoholics, and other addicts, gamblers demand cues associated with their vice. A casino does more than simply provide a volatile negative expectation redistribution of funds. It also must provide what the industry calls "gingerbread." Resorts are themed in various ways (Caesar's Palace, the Bellagio), and aspects of community are provided with nice restaurants, shopping, and social events: in other words, all of the things brain-damaged extroverts need to distract themselves from even a moment of introspection. Even at the micro level, slot machines obscure their brutal, mathematically ordained outcomes with game themes. Some gamblers prefer a Wheel of Fortune themed game. Others may prefer one themed from a recent action movie. Similarly, a feature of meme stonks and crypto is some sort of plausible story to provide gingerbread for the gambler. Just as some people believe there is a strategy to win at lotto or slots, the stonk gambler needs a rationalization for destructive, addictive behavior. The best stonks have some compelling story: Elon Musk is Tony Stark, the idealized version of themselves every nerd can idealize, and will eventually own the entire transportation market worldwide and the entire planet of Mars. Crypto is the new gold, or the new currency, and if you don't want to be stuck holding wheelbarrows of worthless dollars, left behind by our new crypto kings, you'd better get in early. The key quality of a stonk or crypto is that it must have no objective value, and with no objective value, its value could be anything. Communities form around these memes that are emotionally meaningful to the participants, including a penchant to engage in infantile bonding behavior (literal baby talk with words like "tendies").

3. It is impossible to analyze the casino business from an objective perspective. Objectively, they provide no real economic value (or at most very expensive entertainment value), which is one of the reasons most jurisdictions severely restrict or ban their operation. Nevertheless, where they are allowed to operate, they are consistently profitable. Perhaps the best explanation for the emergence of meme stocks and the crypto bubble is in-person gambling being shut down during Covid, along with the more recent crackdown on online poker. Those animal spirits demanding their dopamine hits (and frankly, a salve for the profound loneliness in the culture) had to find an outlet somewhere.

I think some value investors are operating under an old paradigm where a stock's value is equal to the net present value of cash flows delivered to the investor. But stonks and crypto can pay a different type of dividend in the form of neurotransmitters to gamblers. Once a stock or crypto becomes a meme, it is as useless to attempt to short it or otherwise predict its crash as it is to predict when the lotto will pay out. With the recent short squeeze of Gamestop, short sellers have to be extra cautious that they will be targeted with a campaign of forced bankruptcy and margin calls before their bets can achieve their "rational" value. On the flip side, no one can "call" my oil royalties or tobacco dividends, no matter how low innumerate or irrational ESG managers sell the stock. If well managed, these shares are being bought back in an accretive way anyway, limiting the mark-to-market downside.

It is possible, maybe likely, Tesla and Bitcoin will continue to trade at high levels simply out of their entertainment and gambling values. If recent years have taught us anything, never short the stupidity of the Kwa's population.

Once the Covid crisis is over, it will be interesting to track publicly traded casino earnings. Does legal gambling in stonks increase or decrease their foot traffic?

Tesla's "Full Self Driving" Beta Is Just Laughably Bad and Potentially Dangerous

That's not me saying it - it's Road and Track yesterday!

A beta version of Tesla's "Full Self Driving" Autopilot update has begun rolling out to certain users. And man, if you thought "Full Self Driving" was even close to a reality, this video of the system in action will certainly relieve you of that notion. It is perhaps the best comprehensive video at illustrating just how morally dubious, technologically limited, and potentially dangerous Autopilot's "Full Self Driving" beta program is.

In a 13-minute video posted to YouTube by user "AI Addict," we see a Model 3 with FSD Beta 8.2 fumbling its way around Oakland. It appears hapless and utterly confused at all times, never passably imitating a human driver.

The world is catching on to Elon Musk.

• He's not good at building cars.
• He doesn't have a proprietary advantage in batteries - his are outsourced.
• He doesn't have an autonomous vehicle program - he's not even trying to compete at the level of Google or GM.
• He doesn't have any solar energy business.

Ford sold two million vehicles (and a million trucks) in 2020. They are down to a core of great products: the F-Series, the Explorer/Expedition (sells more than Tesla in the U.S.), and the Mach E looks very promising. Their driver assistance is on par with what Tesla calls "Full Self Driving".

Ford has a $50 billion market cap. That seems like a ceiling on what Tesla could be worth (i.e. about $50 per share) when people realize that the traditional OEMs are eating Elon's lunch. As someone put it on Twitter today,

Tesla's sole advantage was as the first mover. But unlike Amazon,Twitter, eBay, FB, etc, where network effects prevent competitors from encroaching on their marketshare, Tesla has none of that. All the auto manufactures are entering the EV market. Tesla as an investment is toast.

Tesla's Junkyard of a Factory

Tesla bears survey the Tesla properties pretty consistently with drones and take aerial photos of stuff like these photos of the main Fremont, CA factory. 

Why wouldn't you scrap the rusty frame there in the second photo? Maybe because it's still on the books at cost.  

Everything in these photos is waste. You can't sell at a profit when you have ten competitors who have figured out how to make the same goods with less waste. A messy factory is an unprofitable factory.  

This is not normal. Look at a satellite photo of the Honda Assembly Plant in Lincoln, Alabama - where all Honda Odyssey vans are built. There is not a single piece of trash or debris on the ground anywhere. 

How do you spend $1.5 billion on buying bitcoin instead of cleaning up this mess? 

The last company we followed with premises that looked like this was Molycorp.

Tesla

Musk is playing with fire by buying coinz while negative business developments for Tesla vehicles roll in. I'm sure it's popular with the nerdy meme traders, but for institutional investors it's hard not to notice that he's putting capital into emitting more carbon while the legacy OEMs are pouring money into R&D and developing competing models. 

The EVs hitting the market now are getting good reviews. I think a lot of Tesla buyers are going to want something that looks new/different from the more established luxury brands with more cachet:

According to Audi head of design Marc Lichte, the 2022 e-tron GT is the best-looking vehicle he's ever designed. We tend to agree and would go so far as to say it's one of the best-looking EVs out there. It's a vehicle that, regardless of powertrain, would be welcome in the garage of the type of driver who wants to sit behind the wheel of something beautiful. One look and it's clearly an Audi. Except that underneath, it's also a Porsche.

Meanwhile, Tesla's range stats are consistently inaccurate. There are any number of powder kegs under his business that would be like the VW scandal (Dieselgate): exaggerated ranges, fake full self driving, and warranty problems from the poor build quality.

Electric Vehicle Competition

One of the things I'm watching that could pop the Tesla bubble is an onslaught of electric competition from the other automakers. I put together a collection of reviews for some models that look really compelling:

•  I've seen a couple of new Porsche Taycans in my neighborhood. Car and Driver: "The Taycan takes everything good about electric performance cars and amplifies it." There are four models: Taycan ($81k), 4S ($105k), Turbo ($152k), and Turbo S ($186k). The EV Porsche in particular is attacking Tesla from the high end. The high end Teslas have a stale design, are no longer uncommon, and have dorky drivers. Buying a Porsche gets you away from that.
• On the low end, VW is selling an ID.4 SUV. Review: "Already priced below the Mach-E and Model Y before federal and state discounts, buyers who apply the full $7,500 federal tax credit can pocket healthy savings by choosing the VW over the Ford or Tesla." Base price is $41k.
  
• Also by VW/Porsche is the Audi e-tron. One review: "This is an electric car that doesn’t seek to blur boundaries or act radical, but simply persuade regular SUV buyers to make the jump. Audi refers to this as ‘concept clarity’." This starts at $67k and goes up to $84k. 
• Then there's Polestar, which is a Volvo (Geely) marque. Their latest model is the Polestar 2, where the entry-level "Launch Edition" is $61k. Review: "The Polestar 2 is an excellent luxury electric vehicle, even if it's not as visually exciting as trendier alternatives."
• Ford is selling a Mustang Mach-E, starting at $44k. Review: "While it doesn't drive or sound like Ford's pony car, the Mustang Mach-E is an accessible and stylish EV."
  
• Mercedes is making electric versions of pretty much their entire product line, starting with an EQA model in 2022, a compact-crossover.
• The Hyundai Kona EV starts at $39k. If you had to buy an all-electric EV, a Hyundai might be a pretty good choice: "Playful handling, long driving range, fantastic standard warranty."
• Lucid has announced specifics for the Air which will supposedly be on sale this year.
  

For people who actually care about economical transportation, there are still the Kia Niro (hybrid), Nissan Leaf, and the Chevrolet Bolt. These are far cheaper ($30k range) than the "luxury" (aspirational) models above. 

• "The Toyota Prius has long been the car of choice for buyers in search of an affordable hybrid—but it's a segment that the handsome and practical 2020 Kia Niro ought to dominate instead."
  
• "While luxury brands such as Audi, Jaguar, and Tesla grab headlines with luxury EVs, the 2021 Nissan Leaf quietly serves the proletariat an affordable, all-electric method of transportation."
• "The Bolt hatchback isn't exciting, but it has the range and practicality to attract and satisfy first-time EV buyers."
  

By now the other automakers have belatedly realized that Tesla's existence and overvaluation threatens them. Introducing all these electric models will cannibalize Tesla sales and also decrease Tesla's revenue from selling EV offset credits to the other manufacturers. If Tesla sales and regulatory credit revenue start to decline, it will be very difficult not to notice the overvaluation.

The Q4 2020 earnings season has put the overvaluation in stark relief. The market capitalization is so high now, at $750 billion, that it is not really possible to make a credible justification for it. It is as much a creature of momentum and positive feedback as GameStop. The current Tesla market capitalization is about the same as that of Facebook. They are the fifth and sixth largest public companies in the United States, behind only Apple, Microsoft, Amazon, and Google. Facebook's enterprise valuation is about $50 billion cheaper than Tesla, since it has significant amounts of net cash that Tesla does not.

Facebook earned $11 billion in Q4 2020 and $29 billion for the full year. Facebook's net income is equal to or even greater than Tesla's entire revenue. For the entire years 2019 and 2020 (combined), Tesla had a net loss of $139 million despite over $2 billion of regulatory credit sales to other automakers. Gamestop and the other short squeezes show that momentum investors buying call options can push share prices to arbitrarily high levels that are not connected with business fundamentals.

Hence, Tesla became overvalued by more than an order of magnitude. It is truly the odd man out in the list of companies with market capitalizations over $500 billion: they generate tens of billions of annual profit and return cash to shareholders, while Tesla still has to raise capital externally.

"There once was a stock that put to sea..." $GME

Analysis by L0m3z:

"What the institutionalists can never understand about the meme stock bros is their loyalty. When they say Hold The Line, they’re acting on spontaneous, organic fealty not just to their own individual bottom line financial interests but to the spirit of solidarity w/ their bros. No nation to believe in, no church, no community, (in many cases) no family...people are finding something bigger than themselves to belong to, and they are putting the collective energy of that tribe into action against who they identify as robbing them of the above."

One issue I see is that the autist traders have great discipline but they don't appear to have an exit strategy for this scheme. As one of our correspondents puts it,

The funny thing about the song is it essentially admits there's no end game here. I mean maybe the rocket into the sun is just ironic gallows humor, but "One day when the trading is done we'll take our gains and go." Trading is never done. How do you take your gains except by selling? Well, who are they going to sell to? The stock has gone full meta. It's a coin now. I've said stocks have gone full coin, this is what I'm talking about.

They've squeezed a low-value company to an amazingly high price.

Is a retailer that loses money on $5 billion of annual sales really worth $20 billion or more?

The GME squeeze was prefigured by the Tesla squeeze. No, nobody ever thought Tesla was worth this much. It was just a squeeze. You can tell by simple dimensional analysis that the valuation of Tesla is off by more than an order of magnitude.

And is it finally time for that tired Boomer stock to go out to pasture? As @EricBalchunas writes, the rolling 10-day volatility chart for $GME makes $TSLA look like a money market fund.

"If you use the benchmark, you will have to have Tesla"

My cynical prediction was right: Tesla will be included in the S&P 500.

This is not new information, but the question is what investors should do about it. There is the primary effect of adding a new stock that will be the sixth largest to the index and will represent 1% of the index. If you use the benchmark, you will have to have Tesla. All passive investors are now betting on Tesla.

Tesla had to go into the S&P 500 index once the price was squeezed high enough, because to exclude it on the basis of skepticism or suspicion would have been an active choice of security selection. It would have implied that the market could be hugely inefficient, that the entire philosophical predicate of indexation was wrong.

I do have one prediction about how things will go post-inclusion. As a Tesla bear for the past several years, one thing I have found is scorn for the "TSLAQ" skeptics from others in the marketplace and the media. If you pointed out a problem with Tesla, people's attitude was "why do you care?" There was a general sense that this is a company owned by dorks and making cars for dorks, and why would anyone but a TSLAQ autist take it upon himself to go probing into the situation?

That is about to change. First, the valuation is so much higher than it was before. It is now $562 billion while just one year ago it was only $62 billion. But more importantly, practically everybody in the country is going to own some of the stock now, and it is going to be their sixth largest holding in any market-capitalization weighted vehicle. 

It was not too big of a story when an "intoxicated driver of a Tesla Model S on autopilot mode crashed into a Department of Public Safety patrol car" on the freeway in Arizona. Or when a Tesla payables person got indicted for keeping two sets of books - and then disappeared without a trace.

The valuation and forced ownership by the entire country should attract more attention. Remember, $562 billion is as big as Home Depot and Walt Disney combined. Profitable household names like Starbucks, Wells Fargo, Union Pacific, and so on have tiny market capitalizations in comparison.

We should also note that the half-trillion dollar valuation has attracted the attention of autistic Big Short Michael Burry. You think that Elon's scam can withstand a guy like that?

@pdxsag on Tesla's China-only recall of whompy suspensions

Our friend @pdxsag writes in with some thoughts about the recall - only in China - of Tesla Model S and X vehicles with "whompy" suspensions:

I don’t think NHTSA wants to be seen as playing second fiddle to China on the world stage, like the FAA was, but two smoldering craters is kind of hard to ignore. Ball joints on a legacy model that is all but out of production is easy to ignore.

Backing up, obviously over-priced story stocks are avalanches waiting to happen where you never know what is going to be the event that sets off the cascade, but this has the potential to be “it.”

This is where the Ben Hunt interview on TC helped me to understand how group thinking about frauds goes… I forget exactly how Ben put it, but basically there’s a fiction where everyone knows, everyone knows, but there is tacit agreement to pretend everyone doesn't know, until something comes along to prick the bubble and they have to switch from pretending to not pretending. (This is the Naked Emperor story. Autists think it is about having the courage to be the boy. It’s really about Empaths' ability to operate in face of an obvious lie.)

So, a Model S recall could be that prick. It comes down to i) "everybody knows” Elon is protected ii) if Elon is not protected, Tesla is toast iii) a recall signifies Elon has lost his protection.

The question really is: does a Model S recall in China cause "everyone” to believe iii).

In isolation, I don’t think so. But if one of two things happen, I think it would. 1) If US recall is so obviously and overwhelmingly expensive it would mean Elon has lost his protection. Or 2) If a recall on the ball joints is followed by additional recalls that would mean Elon has lost his protection.

Tesla could be gone in any given day.

What I Would Buy Instead of Tesla

When I started this thought experiment, Tesla had a market capitalization of $460 billion. It traded around 300 million shares (around $140 billion in value!) at that valuation level. But it has declined and is now a ~$400 billion market cap. So with ~$400 billion in hand, here is the shopping list of what I would rather buy. We can see how this alternative portfolio does over time.

• Toyota Motor Corporation (TM) for $185 billion. Sell the worst automaker and be long the best. Earnings were $17 billion last year. Peak was $23 billion in 2018. Average from 2010-2019 was $13 billion annual. (They made money every year of the decade.) With a market capitalization of ~$185B that's 14x if we look at the ten year average like we do with the S&P as a whole. (Or, only 11x last year's earnings.) Pretty amazing that their net income is close to Tesla's entire revenue (maybe 2/3 of it), but Tesla's market capitalization is 2x higher. TM dividend yield is 3%.
  
• The two U.S. based tobacco companies, Altria (MO) and Phillip Morris (PM) for $72 billion and $117 billion. PM earned $8 billion last year and MO earned $2.3 billion (excluding the Juul write-down). That's $189 billion which is the same market capitalization as Toyota and 47% of Tesla. The P/E of the tobacco companies is about equal to the price-to-revenue of Tesla!
• Valero Energy Corporation (VLO) for $16.3 billion. The second largest oil refiner in the U.S. with 2.2 million barrels/d of capacity. They earned an average of $3 billion per year over 2018 and 2019. The hope here is that the oil refining industry will follow the path of the tobacco industry - a product still in demand but with concerns about the future that discourage entrants to the industry and additional capacity from being added. In this case, the electric vehicle mania is leading people to believe that gasoline demand is going away.
  
• Royal Gold (RGLD) for $7.9 billion. A great business model - streaming/royalty interests on gold mines with no debt. Net income of $200 million for the past year is expensive, but it could/should grow as more mines come into production. (They have interests in 41 producing mines and 16 in development, plus more in the pipeline.) They do about 1 transaction a year but it's lumpy - they did none from 2006-2008 or from 2016-2018.
  
• Texas Pacific Land Trust (TPL) for $3.6 billion. At $460, the market capitalization is $3.6 billion and the enterprise value is about $3.3 billion. (They have a net cash position.) They get a royalty from their land in the Permian and do not do any production themselves. No debt and royalty ownership protects against the risk of ruin in the scenario where there is "deflation first" before an inflation. In 2019, they did $318 million of net income. In the 1H of 2020, they did only $85 million (which annualizes to $170mm). It's a higher quality asset than companies that are more expensive. I think it's a better inflation hedge than precious metals. The big question to me would be whether we overpaid if there's an extended period of deflation. But at least it would be far more likely to survive than something like XOM which has 3x its EBITDA in debt.
  
• AerCap Holdings N.V. (AER) for $3.3 billion. They are an aircraft lessor. This is a covid nothingburger play. It's high risk but high potential reward. It is highly leveraged: they have $35 billion of aircraft (at book value net of depreciation), $10 billion of other assets, and $35 billion of debt, for a net of $10 billion of shareholder equity. Current market cap is $3.2 billion, so very low P/B. The key question is whether the aircraft are worth their carrying values. This was trading for ~90% of book until covid hit. If air travel was going to take a multi-year hit, it would be conceivable that the airline lessees would go bankrupt, reject their leases, and the lessor would be stuck with planes that were worth much less than expected. But, for whatever reason, herd immunity seems to have kicked in far earlier than expected.The Boeing MAX problem is complicated, but if those planes are scrapped it would be bullish for the lessors because it would extend the economic life (and increase the residual value) of existing planes. They earned $246 million in Q2 2020 vs $331 million the prior year. So that is a double digit return on equity. And it makes the P/E about 3x! If lots of airlines go bankrupt, this is a zero. If things return to normal, it's worth close to triple.
  
• Dorchester Minerals LP (DMLP) for $358 million. They own producing and non-producing mineral, royalty, overriding royalty, net profits and leasehold interests. They have no debt. Net income for 1H 2020 of $10 million vs $28 million for 1H 2019. Prices were obviously down during the covid crash, and operators also curtailed production. They bought back some of their own units during April.

So instead of Tesla's $25 billion in annual revenue and no profit (in fact, a cash burn of maybe $5 billion a year), you get revenue of about $400 billion (1x revenue, how about that) and net income of maybe $30 billion a year and distributable (as opposed to reinvested) income that's greater than Tesla's revenue.

Tesla at $500 Billion

He did it. The fully diluted market capitalization is over $500 billion. It's bigger than every other U.S. public company except Apple, Amazon, Microsoft, Google, and Facebook. It has just edged out Berkshire and exceeds Visa and Johnson and Johnson. There would be no excuse not to include Tesla in the S&P 500 index.

For $515 billion (based on fully diluted share count) you can buy Tesla with $25 billion of TTM revenue and basically $0 EBIT.

Or, you could buy: Toyota, VW, Daimler, BMW, Honda, GM, Ford, Fiat Chrysler, and Subaru. They have a combined $1.5 trillion of annual revenue. That's a P/S of one-third of revenue instead of 20x. Just a sixtyfold valuation difference.

Those nine also have $74 billion of TTM EBIT. So they only trade at 7x EBIT. And it would be impossible for Tesla to earn as much because their EBIT is triple Tesla's revenue.

Tesla Bubble Update

Now we are at ~15 times revenue for a car company that has never made a profit.

The Biggest Heist of All Time: Tesla Will Probably Join the S&P 500

An exchange on Twitter a couple of weeks ago with @walt373 and @irbezek:

It was never clear what Musk's exit strategy was for the massive Tesla fraud, but now it is in view. He figured out how to hack indexation and leave a worthless $500 billion turd in the passive investing punch bowl.

Horizon Kinetics has been writing about indexation flaws for a long time. But what would ever “break” indexation? I think it may very well be scammers figuring out that they can loot the index funds, which have abdicated judgment and stewardship of what they own.

It looks like the tools to get in the S&P 500 are accounting fraud (to generate four quarters of profit) and call buying gamma squeezes (to get a big enough market capitalization).

Some Tesla skeptics think that the S&P 500 selection committee can be talked out of adding Tesla to the index. I doubt it. The market cap is now $350 billion and growing. What are they going to do, not have a top ten (by market cap) company in the index? To exclude it on the basis of skepticism or suspicion would be an active choice of security selection. It would imply that the market could be hugely inefficient, that the entire philosophical predicate of indexation was wrong!

No, the whole philosophy of the S&P 500 index is one of freeloading: the active participants in the market are supposed to set prices, which passive investors can then take as fair. So if the market says that Tesla is worth $350 billion, that is not something for index investors generally or the S&P committee to second guess.

Tesla Accounting Fraud

If you are incompetent at manufacturing and have to scrap a lot of parts, you can prevent or delay any financial statement impact of this by keeping the parts on the books as inventory even if you have already thrown them away. It is very simple, comically so, and it makes your gross margin and profit figures look better. The only problem is it is a crime!

[So, if you were a Silicon Valley company doing this, you would need to provide illegal sex and drugs to accounting firm employees, SEC employees, and journalists. One good time to do this and get them on tape for blackmail would be an "anything goes" festival in the desert, where you could have "boom boom tents". It might also help to learn that trade from a master.]

Based on emails that have come out in the Tesla and Martin Tripp litigation (he was a whistleblower whose phone Tesla bugged, and they tried to assassinate him), Tesla distinguished between "physically" scrapping and "virtually" scrapping parts.

In an email from Michael Bowling to Chris Lister and Jens Peter Clausen, Michael Bowling wrote to "request permission" to write off an inventory inaccuracy. He said that "during the inventory we realized 1718 modules in WIP that have already been scrapped physically [were] never scrapped virtually." In the email below, it said that for the week of April 2, 2018, scrap for the Model 3 was $1,920 per car!

It is strange that "permission" would be needed to do this. If a subordinate tells you that an asset on your balance sheet does not exist, you either write it off or you are a fraud. But Jens Peter Clausen wrote, "We properly want to go deep this quarter?" And Adithya Vijayakumar wrote that Mike was "working with the finance team to get the buy off on scrapping the modules for the second quarter."

That makes it sound like actual ground truth is not the final arbiter of what appears in Tesla financial statements.

This is not the first time there have been Tesla cost accounting irregularities. Remember that the government indicted someone in Tesla's accounts payable department for impersonating employees of one Tesla vendor (Hota Industrial Manufacturing of Taiwan) in order to substitute their payment information with the payment information of a different vendor, Schwabische Huttenwerke Automotive GmbH (SHW).

Tesla Now the Biggest Market Capitalization Automaker

I never thought it would be possible, but today Tesla, Inc surpassed Toyota Motor Corporation to be the biggest automaker by market capitalization: $208 billion versus $202 billion.

Does that make any sense? Consider the following:

• Toyota trades around 1x book value and Tesla trades for 20 times book. 
• Toyota sells 9 million vehicles a year and in 2019 Tesla sold 367k, or 1/25 as many.
• Toyota trades for 0.8x revenue and Tesla trades for 8 times 2019 revenue.
• Toyota trades for about 10 times earnings and has been profitable for 10+ years straight. Tesla has never had a profitable year.

EDIT:

Take a look at this chart of Tesla. At the end of 2019 the price and valuation went absolutely insane. It happened at the same time that their growth stopped!

Neil Campling: "Who’s going to be the next Wirecard?"

He has 20 warning signs in trying to determine the next "Big Disaster" like Wirecard. Note, he has someone specific in mind who checks all of the following boxes:

1. Massively promotional CEO who actively looks for publicity and spends a lot of time courting Wall Street/investors etc and is very media savvy.
2. Huge CEO/Senior Management compensation package NOT tied to cash flow or Earnings but just to Sales and/or the stock price, creating the possibility of egregious wealth creation if the stock goes up a lot. Huge pledging of collateral by the CEO in return for margin loans to fund a billionaire lifestyle.
3. Management compensation generally way out of line with peers despite notably less profitability.
4. Glossy future projections that have a habit over a long period of being proven to be too optimistic.
5. Questionable product quality, ie defects (boon??) or debatable technological leads over similar products.
6. Some evidence of self certifying, whether it be through strange international subsidiaries or not having an Auditor or experiencing unusual and slightly sudden end of quarter surges in revenues, up to and including the last day.
7. Unusual or unverified and large Receivables in a business where the product is exchanged for cash up front.
8. Evidence that the company is existing on a shoestring, not paying Suppliers, Employees, Landlords etc.
9. Unusual margin progression, with SG +A going down over time despite a rising global footprint, or GM's staying flat despite much lower ASP's over time, for instance.
10. High levels of Gross Debt. Cash balances not matched by notable Interest Income thereby suggesting they are fraudulent.
11. High employee turnover, especially in the LEGAL and FINANCE areas. Co-founders or Board members leaving.
12. Aggressive pursuit via paid third parties and/or “heavies” of any critics or people who have too many questions, which in any case are “boring”.
13. Dislike of Hedge Funds.
14. Possible Narcissistic Personality Disorder on the part of the CEO. Additional points if he/she uses Twitter a lot.
15. Large cabal of outcasts/weirdos/bloggers/Twitter groups who have been saying for years that everything is amiss but just get a lot of criticism because the stock keeps going up ergo they must be idiots.
16. Slowing top line growth rate despite all the hoopla and supposed “growth stock” status. Evidence of competitors rapidly eroding unsustainably high market share.
17. Loss making. Ideally never made a profit but likes to pretend it did or failing that, that it will for sure in 2-3 years due to highly questionable new products. But the 2-3 years gets pushed out constantly.
18. Extensive use/exclusive use of NON-GAAP Accounting and occasional bridging to get from a Net Loss to a (small) Net Profit via poorly explained one-offs/Other Items/unusually large Credits of some kind in a desperate attempt to get into an Index by illicit means.
19. Weak Board, preferably also small and ideally in hock in some way to the CEO, who therefore do his/her bidding. Helps if some of them are related physically to the CEO.
20. Gullible media, gullible analysts and dozens of paid bloggers who produce Price Targets out of nowhere based on “Option Value” or put another way products that are at least 5 years away from having any material impact.

Resurgence of Bubble

The U.S. has had three bubbles in 20 years: late 90s, 2005-2008, and the current one.

Each one has been bigger and crazier than the last.

Just the bear market bounce (April/May/June 2020) of this third bubble is crazier than any bubble before it:

Our correspondent @pdxsag (previously) writes in:

Today I had an epiphany that the markets — as they glory in their wanton, unchecked fraud — are now exhibiting the same dynamics as a crowd looking to riot.

As the Scholars Stage blog explained, riots are inherently a coordination problem. The same can be said for pump & dump schemes. If you consider investors as a motley crew of animal spirits, it would certainly stand to reason that at any point in time there exists a non-trivial number of investors that would gladly engage in blatant pump & dump stock manipulation. Their problem, of course, is how to coordinate. Like soccer hooligans looking for a riot, they need “an incident.”

If you’ve been dumb-founded by the stock runs in HTZ and CHK, it hopefully will make perfect sense when you realize that the bankruptcy filing is now the easily and universally understood “incident.” It’s akin to the sound of broken glass in a real riot. When a company files for bankruptcy protection pump & dump “entrepreneurs” quickly bid up the price to see if it "sticks.” If it’s not halted, if the exchanges and SEC make no effort to arrest the run then more traders jump on the stock driving the price higher still. Pretty soon it’s like a Macy’s being looted as hundreds of people are crashing into the stock looking to grab a quick buck and be gone. The daily volume when a stock is undergoing a viral pump & dump can be 10x of the float or more. Day traders, I suspect many of which are algos, are churning through blocks of shares not holding any individual shares for more than a few minutes at a time. Sure there is slippage with all that churn, but it’s important to not be caught holding the hot potato.

Another example of a now too obvious incident is the transparently fraudulent press release. In this market, where investors freely quip "Fraud is Alpha,” it stands to reason that a fraud-y press release is a clear signal from management to day traders that they are looking to play ball. Elon Musk has notoriously refined this to an art. In fact, today Tesla closed above $1000 for the first time ever on the back of a “leaked" email from Elon related to the development of the Tesla semi. The impetus has nothing to do with the business prospects of the semi, and everything to do with significant OTM call buying yesterday to get people’s attention and an incident today in the form of the leaked email.

We’ve seen similar incidents with various Covid vaccines news stories, press releases, and TV appearances by company CEO’s.

The markets are in one giant, late-stage pump and dump, and the regulators — like the police across many cities today — are overwhelmed and conspicuously enough to any bad actors looking for an easy looting, are standing-down.

Compendium of Tesla Research Links for $TSLAQ

Someone on Twitter made the good point that,

"the single most important thing $tslaq can to chip away at musk's SEO manipulations is, if you run a website or frequent a forum/msg board/subreddit, link to articles (moreso than tweets) about his dumb outbursts, essays on his financial shenanigans, @plainsite lawsuit pages"

One link that Musk definitely does not like is Tesla Deaths which "is a record of Tesla accidents that involved a driver, occupant, cyclist, motorcyclist, or pedestrian death, whether or not the Tesla or its driver were at fault." It even has a column for "Verified Tesla Autopilot Death"! (Also, be sure to read the stories Tesla’s Latest Autopilot Death Looks Just Like a Prior Crash and NTSB blasts Tesla, CalTrans, and NHTSA for Autopilot death.)

There are two podcasts, TeslaCharts and Quoth the Raven, and their corresponding Twitter accounts (TC and QtR) which both cover Musk and Tesla in detail.

There is a site called Crowdsourced Tesla Research, which posted a compendium of 122 sudden unintended acceleration Vehicle Safety Complaints Filed With the NHTSA by Tesla Drivers.

A great site called Elon Musk Today (subtitle: The Future Ain't What It Used To Be!) posts Elon Musk promises and predictions and the number of days subsequently elapsed without them being fulfilled. For example, it has been 3,010 days since Elon Musk said Tesla will never need to raise capital again on (2/12/2012). It has been 594 days since Elon Musk said Tesla would start producing car carriers due to car carrier shortage on (9/24/2018). This site gives complete accountability for his bogus predictions.

Then, PlainSite published an immense report on Tesla fraud which he calls a "Reality Check". PlainSite also has great visualizations of Tesla and Musk litigation filed over time, for example pertaining to Model 3 vehicles, Tesla Vendor Non-Payment, Tesla Solar, and Tesla securities fraud.

Why does Musk have so many broken promises and why do his companies get sued so often? He is running a fraudulent stock promotion scheme. See David Einhorn's questions about Tesla's financials:

• The question of Tesla’s cash to be collected
• Investor Einhorn tweets at Tesla's Musk asking for more company financials
• Famed short-seller David Einhorn calls out Tesla's billing practices again

There was a very interesting tweet from PlainSite yesterday about Tesla global registrations vs deliveries: "With the updated and fixed Washington data, and updated New York data, the overall $TSLA sales-versus-'deliveries' graph is still appropriately hideous with an unexplained gap of about 120,000 units. Even if 20,000 are from southeast Asia, that's 100,000 'deliveries' unexplained."

This seems like it could be a very big piece of the Tesla puzzle. Fake sales would generate fake cash, and it really seems like Tesla does not have the cash it says it has - slow paying bills, store shutdowns, low interest income on cash. Also, having to raise cash when it supposedly has billions in the bank. (And then not being able to use this raised cash for expansion capex.)

I am interested in trying to rebut the idea that the ~100k deliveries were legitimate even though the cars did not end up being registered in any of the regions where PlainSite has data. One idea I had was how do the worldwide deliveries and registrations map to the Tesla service center locations? Or, how do they map to other vehicle sales numbers, like those disclosed by other luxury brands, or by the countries themselves?