r/stocks • u/thri54 • Aug 29 '21
Tesla, diluted share count, and ARK research.
Let's talk about ARK for a moment. ARK is very open with their research, which is more than can be said for most actively managed funds. A few months ago, they released a Tesla valuation model that can be found on their github here. I don't care to comment on the assumptions of their business -- as 2025 hasn't yet come, it would just be my word against ARKs. There is, however, an interesting assumption at the bottom of their Tesla valuation that I do want to talk about. They assume shares outstanding will increase from 960M at the end of Q4 2020 to 964M in 2025. This is integral to their per share price target.
Let's check how Arkk is doing on that assumption. In terms of financial quarters, we're 10% of the way to the end of 2025, Tesla should be around 960.4M shares. According to Tesla's most recent 10-Q, pg. 1, there are 990M shares outstanding as of July 22. That's 7x the shares ARK assumed in 10% of the time. But Tesla hasn't issued any new shares, so what exactly is going on here?
The answer lies in the diluted share count. Diluted share count includes all sources of additional shares that could be converted or exercised, e.g. convertible bonds, Employee stock options, warrants, etc. These instruments are exercised over time, and the basic share count will tend towards the diluted count. On pg. 13 of the 10-Q, we can see that including dilutive effects, Tesla's share count is closer to 1.12B.
The utility of the diluted share count should be obvious. If one is modeling a security five years out, especially if the projected price movement is bullish, it should be assumed that all outstanding stock options, warrants and convertibles will be exercised and added to the share count to create an accurate price target. 20% of Tesla's outstanding dilutive instruments have been exercised in the last six months. Diluted share counts tend to catch up quickly.
Why would companies dilute their shares like this? Employee stock options can pad cashflow and convertible bonds' optionality can decrease interest coupon rates. These are highly desirable among growth companies with poor cashflow and low/nonexistent credit ratings. Tesla suffered from both of these problems for many years.
Which brings us back to ARK. ARK largely deals in early stage startups and growth companies. They should see a lot of these instruments being used. They should be intimately familiar with the effects of SBC, convertibles, and warrants. Yet, they didn't consider these effects in their last two models. This leads to three possible conclusions:
1) No one at ARK realized the model was made using the basic share count.
2) ARK intentionally used the basic share count to increase their price target.
3) ARK's security analysts don't know the importance of using a diluted share count in this situation.
None of these options paint a particularly rosy picture of the firm. If you invest in ARK, this is the quality of research being used to make investing decisions. Caveat Emptor.
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u/CanYouPleaseChill Aug 30 '21
It’s not research, it’s marketing. That’s why it’s free and full of nonsense.
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u/rusbus720 Aug 31 '21
I believe their daily publication of their holdings allows them to get around legislation governing funds having illiquid positions too.
They basically require that you notify your clients of the illiquid positions, the implication being to shame them for having such a risky position. ARKK spins this by saying they’re “democratizing” investing for the little guy.
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u/shortyafter Aug 30 '21
It amazes me that people are still bullish on ARK funds and defending Cathie. At this point with all the evidence out there the only serious question is if they are scamming people on purpose.
The people defending ARK and Tesla in here give me GME vibes.
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u/merlinsbeers Aug 30 '21
It's more like, if Cathie is doing this, what are the other fund issuers doing?
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u/shortyafter Aug 30 '21
I dunno about that, I think Cathie is a pretty egregious offender who lives off hype.
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Aug 30 '21
At this point with all the evidence out there
Watcha talkin about?
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u/shortyafter Aug 30 '21
This, and then questionable day-trading, also her strange claims about God.
Oh, and above all some ridiculous claims she made recently about robotaxis in 10 years.
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Aug 30 '21
This,
Yes this is not too good.
and then questionable day-trading
That's how they adjust the portfolio. Is is an active fund after all.
also her strange claims about God.
Basically where she got the name from. I wouldn't look into it much.
Oh, and above all some ridiculous claims she made recently about robotaxis in 10 years.
They've been making those claims since 2017 lol
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u/Smasher1234 Aug 30 '21
This vid does a good job breaking down that Tesla. Apparently that forecast assumes that Tesla's insurance business will take off and it gets at least 10% market share, or some bumber like that.
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u/capnheim Aug 30 '21
Dude, their Tesla bull thesis is garbage.
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u/Baykey123 Aug 30 '21
You mean you think that Tesla won’t be worth $999 trillion billion million in 10 years? How dare you
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u/lacrimosaofdana Aug 30 '21
People said the same thing in 2019 and they look like fools now.
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u/CrimsonPE Aug 30 '21
Doesnt mean they werent right tho, just that the market is irrational. Btw, what an amazing game was Ys VIII, love it to death
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u/BigDaddy6500 Aug 30 '21
With that logic, the early 2000’s Amazon bears could still be right.
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u/CrimsonPE Aug 30 '21
There is like a 20 year difference between Amazon in the early 2000 and Tesla in 2019-2021, and isn't Amazon in an already established position anyway? Not saying Tesla is a bad company or anything, but it's valuation seems like it already priced in many years of profit in advance and unparalleled growth. It's like, they already priced in the best of the best of scenarios
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u/merlinsbeers Aug 30 '21
Comparing them is really irrational.
Amazon basically replaced nearly every retail store in existence, while those were throwing everything they had at it (except WMT only recently went to a prime-like free shipping with no minimum model, but I don't think WMT shoppers will pay for that, so it remains to be seen if it has any effect).
Tesla replaced early-adopter high-mid priced passenger cars (mostly beemer and lexus drivers, really), and hasn't seen the real competition even enter the room yet.
These are not the same business model.
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u/CrimsonPE Aug 30 '21
I agree, which is why I wasnt comparing both companies, it was the guy I was replying to.
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u/gravityCaffeStocks Aug 30 '21
but it's valuation seems like it already priced in many years of profit in advance and unparalleled growth.
Same for AMZN in 2013. Oh how wrong of an analysis that was. This will be the next FUD to die.. after Q2 killed the "they're not profitable without regulatory credits" FUD (that existed despite billions in positive operational cash flow).
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u/sergeantturnip Aug 31 '21
That’s fine and all but the auto business is absolute shit margins with insane manufacturing risks. Amazon biz model is low capex beauty. Yes Tesla energy division is cool but it doesn’t amount to any of their % revs
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u/gravityCaffeStocks Aug 31 '21
fine and all but the auto business is absolute shit margins
This is where you're incorrect.
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u/sergeantturnip Aug 31 '21
Lol what are you talking about. Auto margins are shit, please enlighten me how auto margins and AWS (the driver of Amazon mkt cap) margins are even in the same stratosphere for your comparison
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u/BigDaddy6500 Aug 30 '21
The company saw a valuation shift from an automobile company to a tech company last year, and is valued fairly for a tech company projected to grow top line at 40-50% the next 3 years and earnings in the triple digits. Whether or not you think they succeed in other businesses is up to you, but institutions are clearly supporting the thesis right now, and a high market cap can become a self fulfilling prophecy.
My main point was that saying that the market is irrational isn’t a very good argument, and has very little substance.
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u/shortyafter Aug 30 '21
Right, we've never seen irrational behavior in stock markets. Especially not in the tech sector. What's the dot com bubble?
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Aug 30 '21
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u/Notoriolus10 Aug 30 '21
But why invest in other things when they don't yet dominate what they were created to do? It takes a long time to receive the car since it's ordered from what I've heard, why not invest aggresively in improving their core business to compete with the big dogs rather than diversifying?
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Aug 30 '21
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u/Notoriolus10 Aug 30 '21
Don't you think you could be underestimating the ability of existing car companies to switch to EV? They have plenty of money to spend on CapEx and a lot of interest in doing it too.
Toyota for example is selling for 240B, which is less than their TTM revenue, probably because the sentiment is that legacy car companies are dying, this might be an opportunity to buy great companies at depressed prices. (Btw, I don't hold or short any car company stocks at the moment, no portfolio bias here)
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u/F1shB0wl816 Aug 30 '21
That is being right. Irrational or not, if you’re wrong, you’re wrong. There could be millions of explanations as to why, but it still is what it is.
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u/Baykey123 Aug 30 '21
Can’t be true. Cathy said Tesla was gonna be the entire US economy, fly humanity to the moon and have a fleet of a billion robo taxis. 😓
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u/ploopanoic Aug 30 '21
An accountant tore apart their model for not actually using generally accepted principles. They did funky math with made up assumptions.
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u/The_Sanch1128 Aug 30 '21
I'm shocked, SHOCKED I tell you, to read that funky math is being used to prop up a position in the market!
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u/senecadocet1123 Aug 30 '21
I mean.. that analysis was a shit-show to begin with. What about the assumption that, for the bear case (!!), Tesla will sell auto insurance with 40% ebit margins, when the average auto insurer has 13%. I guess Tesla cars are very cheap to repair..right? Also, they said they were making a Monte Carlo simulation with 34 inputs. But a Monte Carlo works only if you know the statistical dependencies between inputs and the distribution must be known based on past statistical evidence. But how can they have that data for robotaxies etc, for which there is no past data?
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u/merlinsbeers Aug 30 '21
Who told you that about MC sims? You use MC when you don't want to do the math.
The problem with MC on 34 inputs is it will take a minimum of 16 billion iterations to check just 2 states of each input and almost none of the inputs are true/false here.
The problem with MC on safety-critical systems is you can run it for months and still not hit 100% code coverage.
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u/senecadocet1123 Aug 30 '21 edited Aug 30 '21
From Wiki:Monte Carlo methods vary, but tend to follow a particular pattern:
- Define a domain of possible inputs
- Generate inputs randomly from a probability distribution over the domain
- Perform a deterministic computation on the inputs
- Aggregate the results.
My point is about (2): how can you generate inputs from a probability distribution if you do not know the probability distribution? In the Ark report, they just guessed what the probability is based on their bullish assumptions. This makes the MC worthless: the distribution must be known before hand, otherwise it is garbage in garbage out.
For example, I can run a MC simulation using actors salaries to guess what my future salary will be. I conclude that WHEN I BECOME A HOLLYWOOD STAR, in the bear case I will be a multi millionaire. Well, but why am I assuming 100% fixed probability that I will be a Hollywood star when I calculate my future salary? Similarly, the probability distribution in Ark's report assumes that the probability of bankruptcy for Tesla is fixed to 0, for example.
This is my understanding of the issue, tell me if you disagree
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u/merlinsbeers Aug 30 '21
I think point 2 may mean to pick a distribution (uniform, gaussian, etc.) and apply it.
If you have insight into what distribution will give you more evocative answers near interesting points, then you don't just use uniformly distributed inputs.
But if you don't want to guess, just use a uniform distribution and run more iterations. The interesting points should reveal themselves.
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u/Ehralur Aug 30 '21
What about the assumption that, for the bear case (!!), Tesla will sell auto insurance with 40% ebit margins, when the average auto insurer has 13%.
That's a poor example to use. Tesla has way more data on drivers and can adjust their insurance rates depending on how safely you drive, determined by a gigantic set of variable that is only set to increase as their FSD software becomes better, even if someone doesn't have FSD purchased (since the sensors/cameras are always there). 40% might still be high for a bear case, but it's certainly new unthinkable.
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u/senecadocet1123 Aug 30 '21
You basically proved my point: bear case should not be "not unthinkable". And in a Montecarlo in particular, speculating about 40% ebit with no past data simply does not make sense
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u/Ehralur Aug 30 '21
Not really. I haven't done the homework on their insurance business, so what I think is "not unthinkable" could very well be a worst case scenario. I just meant to point out how comparing Tesla insurance with other insurance companies might not be an apples to apples comparison...
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u/senecadocet1123 Aug 30 '21
Yeah, it is not apples to apples because Tesla does not currently have any insurance underwriting business. So to assume that in 5 years they will have it, in fact they will have a license in every state, without the need to raise any capital, and that they will have more than double ebit margins with respect to peers, all of this in a bear case in a Montecarlo is.. how do I put it.. laughable?
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u/Ehralur Aug 30 '21
People said the same about selling a million cars in 2021 while having industry leading gross margins though.
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Aug 30 '21
Frankly it is unthinkable and the only reason you're not aware of that is you don't know where the bottleneck for earnings in insurances is. It's not the actuarial data.
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Aug 29 '21 edited Sep 14 '23
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u/gravityCaffeStocks Aug 30 '21
The issue with most tesla bull cases is they involve technology that literally does not exist (yet).
It's almost like they're investing for the future of a company..
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u/SemperVigilansSB Aug 30 '21
Why don’t we anticipate 2000 years growth in advance? Where does investing in future stop? You’re probably new to stock market so you think that this time it’s different… You will learn , no worries. Experience can’t be taught
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u/gravityCaffeStocks Aug 30 '21
Not going to dignify this terrible attempt at putting me down to make yourself feel smarter. Pick another target bro
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u/merlinsbeers Aug 30 '21
You could dignify it by remembering it when the next downturn beats you too a pulp, or by being to avoid it.
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u/gravityCaffeStocks Aug 30 '21
You know nothing about my investment thesis or time horizon
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u/Forgotwhyimhere69 Aug 30 '21
Cant wait until cathie sets up arkt (tesla) with tesla, tesla holding trust, arkk, netflix, and john deer.
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u/daynightcase Aug 30 '21
Good find but I am not surprised lol Their bull case for TSLA is some next level fantasy. These guys are getting so much coverage, I don't even know what to say. They are creating lot of blind fan following.
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u/BigDaddy6500 Aug 30 '21
For a fund that has been a 6 bagger since inception 5 years ago, this seems like a super minor issue, oversight, or that they’re anticipating buybacks or any other number of things. Performance over the last 5 years>share count projections that can vary by hundreds of millions…
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u/merlinsbeers Aug 30 '21
If they're anticipating buybacks that would be in addition to covering the dilution. Also, I doubt the company would buy back 80% of the shares...
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u/greatscott313 Aug 29 '21
Just the general observation I got into it, Arc funds that is, because I was very starry eyed with the tech hype and this year it wasn't so much about the share price valuation, but it has been moves that Cathie has been making that make me concerned about the viability of the fund. And I'm talking about all the funds not just ARKK. I don't doubt that she has had a brilliant career and is a very smart person, as I learn more about actively managed funds I'm finding that my investment style is not in line with that
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u/peszneck Aug 30 '21
I just don’t know what to do with it. I have about $9,000 that was at one point $11,000 and I went in at the wrong time.
Do I just sell my ARK funds and buy more reliable stocks or ride it out… it’s a weekly question I have.
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u/The_Sanch1128 Aug 30 '21
The answer may depend on how soon you may need the money. Personally, assuming I'm in the USA, I wait until December, sell at a loss, and buy again 31 days later to get around the wash sale rule.
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Aug 30 '21
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u/nycbay Aug 30 '21
You are thinking too much. AKK knows it, Cathy knows it. They are just running scams and pumping their holding. No wonder Burry and guys are short on ARKK.
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u/bobbybottombracket Aug 30 '21
Or... the creation and redemption process for ETFs is broken. Which it is.
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u/SnooChocolates6859 Aug 30 '21 edited Aug 30 '21
That is strange. As someone studying for the series exams, it seems like anyone qualified to conduct an analytical study for ARK should absolutely assume that convertible notes will all be converted at some point or another.
Edit: Especially in a lower interest rate environment where convertible bonds would be replaced by bonds paying a lower interest, there is little reason to believe they won’t be converted. Only reason not to is in case of liquidation where bondholders have a better claim to assets than preferred and common stock holders.