Tesla (NASDAQ: TSLA) yielded more than 720% for investors in 2020. It’s a great year by any standard, and containers should be very excited about the performance. For many people, however, it creates an assignment problem that requires rebalancing.
As I see it, the worst mistake Tesla investors can make is to ignore the need for diversification. This proposal may fall on deaf ears for speculators or Tesla disciples, but it’s a great time to sell a portion of your stock while retaining it for future growth.
The carmaker has grown aggressively in 2020
Tesla was one of the most popular stocks among investors starting in 2020, and many people owned it as part of their portfolios. That stock has almost certainly grown to a much larger share of their portfolios since the beginning of last year. A hypothetical portfolio that at the beginning of 2020 was 5% Tesla, and the rest spread between S&P 500 and the NASDAQ, Tesla would now be around 25% due to the excellent performance of the one position.
There is some disagreement among Fool contributors and the investment community on this topic, but I am a firm proponent of diversification and rebalancing. This is especially important if equity performance is driven by valuation inflation rather than fundamental growth. In the example above, investors established a volatile, high growth position with 5% of the portfolio. After its value exploded, Tesla now has less upside potential and a downside risk. To repeat this year’s performance, the company needs to grow to $ 5.6 billion in value. Tesla is likely to continue to perform well, and the large valuation can finally be achieved. However, it is going to take a while, and I expect that we will undergo some market corrections before the day arrives.
Tesla holders should be excited: the stock has delivered your profits ahead of schedule without a corresponding increase in sales, and the chances are high that you will be able to buy more again later at a less aggressive valuation.
Rebalance, profit and allocate
Even if you fundamentally agree that rebalancing is important, the actual movements needed to be in balance again can be difficult to accept. Tesla is looking at 30% sales growth in 2020 and made a quarterly profit for the first time last year. Analysts again predict rapid growth in 2021.
It may seem strange to sell a stock that delivers a good return while having a good base and looking forward to another good year. However, this is exactly what you need to do to be effectively back in balance.
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The bull narrative for Tesla has not been disrupted. In fact, the continued growth of the automaker and recent gains confirm the optimism about the stock. Why would you have to sell it if that is the case? Because here is still risk.
Tesla trades at a price-to-earnings ratio (P / E) of 175, a price-to-sales ratio of 24.5 and a price-to-book ratio of 41.7. Investors can expect promising growth stocks to attract high valuation ratios like these, but Tesla holders need to realize that significant amounts of future success are accepted at this price. Continued strong results are needed to justify the current price. Any indication that Tesla may not have the optimistic forecasts of the market could cause stocks to tumble, even as the company grows.
This may not be a problem for bullish long-term holders who want exposure to the ultimate market leader they expect Tesla to become, but others recognize the opportunity to redeploy capital into other stocks that can deliver strong returns without so much risk concentration. Growth investors can sell some Tesla shares and use the proceeds to buy several other high-growth stocks. Recent large-scale stock market offers and hot stocks from industries such as e-commerce, cybersecurity or telecommunications can offer a huge upward benefit, along with the opportunity to dilute the risk of any stocks performing poorly.
Do not overreact
Rebalancing should also not mean that you have to give up a good position altogether. It makes sense to include certain profits and maintain a smaller position in Tesla to capitalize on the potential future growth. Investors may be nervous about Tesla’s aggressive valuation, but the company could potentially become a leader in several major industries in the coming decades. Most investors who allotted a certain portion of their portfolios to Tesla last year should feel comfortable allocating a similar percentage of their stock to the stock this year.
Tesla may have attracted a large number of speculative growth investors, and they may not want to hear it, but it’s a great moment to make a profit and reinvest it elsewhere. The stock has outperformed the rest of the market so drastically over the past twelve months that it has exposed portfolios to its performance. This is especially risky with Tesla’s high valuation ratios. Bully investors need to like these stocks in their portfolios to take advantage of future growth, but there are more than enough companies with great potential to justify diversification.