A single prediction for the New Year. Those unfamiliar with the Federal Reserve Board’s Regulation T will hear lots about it during 2021. The rule limits the percentage of an investment in equity securities that can be borrowed with a margin loan. A wake up call is scheduled...1/

It was widely reported this week that total margin debt reached a new high of $722B. The WSJ’s 12/28 lead Business and Finance story profiled a $TSLA retail investor, a civil engineer, who had parlayed a $23k option investment in $TSLA into a $2m position. Oh boy. 2/

The gentleman is to surely and genuinely be commended for the investment. An 87x gain in a short period is extraordinary (I've never done that, nor will I). That said, a quick perusal of $TSLA twitter commentary and recommendations is terrifying. 3/ https://www.wsj.com/articles/investors-double-down-on-stocks-pushing-margin-debt-to-record-11609077600

One can read the Journal article, Investors Double Down on Stocks, Pushing Margin Debt to Record, and draw two conclusions. One, “This must be extremely dangerous,” or two, “Surely I can get rich quick too.” Human nature being what it is…4/

For the latter, the civil engineer offers this advice on his Twitter page, “If you have no Tesla call options, you may want to do the math and consider using LEAPS as a way to accelerate your accumulation of Tesla stock. 40X in 2020. Another 50X by 2025.” Whoa. 5/

A series of Q&A tweets ensues (thanks for the heads up @RomanRubinstein) on which broker/dealers offer the most margin, the lowest interest rate on margin debt, and how to borrow the most money and obtain the maximum leverage by purchasing call options. 6/

“Maintain margin value of 50% in my portfolio and the margin borrowing rides forever,” goes the advice. Please consider the danger of heeding this advice. The engineer should risk off and live a happy life. A whole bunch of people are going to lose a whole bunch of money. 7/

Reading through a series of tweets among the Tesla (and others) option crowd, you see little, if any, mention of maintenance margin requirements. FINRA requires investors, strike that, speculators, to maintain equity of at least 25% of the value of an account. Leverage kills. 8/

Maintenance rates can be set above the minimum threshold. The concept of posting shares in stocks like $TSLA, $TWTR, or any established company trading for 20x or 30x sales & borrowing half of the value and then buying calls on the same shares posted as collateral is insanity. 9/

The only “math” a speculator should be doing is knowing at what price against the shares in the account will new equity be required. Most brokers don’t wait around for a customer to come up with new cash or securities to deposit. What do they do? 10/

They sell down your shares to get to equity compliance. More decline? More forced selling. Depending on maintenance margin thresholds, you can lose it all in a hurry. Red flags are abundant, beyond simply the new record high in total margin and credit market debt outstanding. 11/

You can see the bubble in the number of single-contract call options outstanding, in the number of new retail accounts being opened with margin and allowed option trading, and even in the tone of surety by speculators regarding prospects for wildly expensive shares like Tesla.12/

I never thought I’d again see the kind of mania like we saw in the late 1990’s, but here we are. Memories of what can and is likely to happen are long gone. Even a number of professional investors have suspended price as a key determinant of value. 13/

A respected and well known retired professional investor suggested on Twitter recently that I don’t understand “$TSLA growth math or basic investment theory,” that “stocks look forward, not backward” and that “P/E’s are a function of exponential growth rates, not industry.” 14/

The last time an investment pro came unglued was January 2000 at a newspaper roundtable. The CIO/PM for one of the largest & oldest growth & income funds at the time took exception to the notion that $MSFT shareholders would lose money for the next 15 years, which they did. 15/

I’d written 6 pages on the prediction in my 1/1/2000 letter (on the website) and discussed it at the roundtable. My co-panelist became unhinged because he and his firm had 5% of capital in $MSFT, which was then a a $620B market cap on $20B in sales, 31x sales & 80x earnings. 16/

You can apply the same logic to $TSLA or to any number of dangerously overvalued fashionable disruptive growers today. The Tesla bull proffering margined purchase of $TSLA LEAPS expects a $1,000 share price this year, $5,000 the next and $22,000 by 2025. 17/

Now, a $22,000 stock price, assuming no further dilution above today’s 1.1B fully diluted shares outstanding, gets you to a $24 trillion market value, which must be reasonable given that the entire market value of the S&P 500 today is only ~$31 trillion & global GDP is $88T. 18/

When your TAM (the new eyeballs) is 100% global auto market share, robotaxi, energy grid, insurance and economic population of Mars, no price is too high. No argument that Tesla has made great strides in manufacturing efficiency and are now producing a more reliable product. 19/

I also believe disruption of the auto industry will require an enormous amount of capital to grow and the established OEM’s won’t play dead. You can't simply separate auto margins and capital requirements from nearly infinite profitability earned by selling software upgrades. 20/

Shouldn’t the upgrades be considered part of total vehicle cost? To what extent did the Apples and Microsofts of the world thrive on a regular upgrade cycle, much of which was and is planned. How often are you compelled into a new iPhone or iPad? 21/

Prior to the subscription model, at what point did Microsoft not support an older operating system or Office suite? Will EV buyers purchase a new car every 2-3 years? How much of the world can afford a more expensive vehicle than the current global average car price? 22/

Regardless of one's beliefs on business quality & growth prospects, paying a too-high price can destroy future investment return. #neversell? When price becomes ridiculous to the most optimistic business case you #bettersell. Price matters and the current environment is nuts. 23/

An investment write-up on $TWTR just yesterday suggested a $98 target stock price by this September, 81% above today’s. That’s an $80B market cap on a company doing $3.5B in revenues that’s raised $9.3B in share capital, $4.3B in debt and produced a cumulative $1.3B loss. 24/

The author looks for 30%+ 2021 revenue growth vs 2.2% LTM, 14% in 2019, 25% in 2018 and -3% in 2017. The valuation target is “justified” on a 2021 EV/Revenue comp of 8x against $FB and versus $SNAP and its expected 40% 2021 revenue growth. 25/

Using $SNAP as the comparator, a $75B market cap, 34x $2.2B in TTM revenues, yes growing at 40%, is what we do for analysis these days. There’s a #fintwit myopia that finds utility to the Twitter network. I certainly have come to do so over the past year. 26/

@patrick_oshag, whose podcasts are unparalleled & whose opinion I respect greatly, suggested he’d pay a large sum to use it if he had to. I'd be a paid up subscriber if required as well. The problem is Twitter is not used pervasively among other professions in the same way. 27/

Kids don’t tweet. Doctors don’t, lawyers don’t, and the guy running #Twitter, @jack, managed to alienate half of users that use if for political news and networking, not to mention that pols on both sides of the aisle are coming with the regulatory gun for different motives. 28/

The current folly for price not mattering, or being justifiably high, reminds me of a well known sell-side report on Berkshire Hathaway in 1998 which assumed as undervalued both $BRK’s shares and its stock portfolio against an assumed “reasonable” 40x market multiple. 29/

Berkshire’s shares, expensive, would fall by half over the next 18 months to a February 2000 low. It’s become fashionable to explain investment process by saying price is the last consideration. Too often lately, price isn’t even a consideration, especially for holy growers. 30/

While I did not have a short position on $MSFT in 2000, I do have a very small recent short on Tesla today so take my comments w/ a grain of salt. I did buy $MSFT in '06 after it fell by ~75% and owned it for a decade, trimming when dear and adding to the position when cheap. 31/

Short selling is very risky and those w/ sizable short positions on Tesla at the outset of 2020 would have suffered real damage given the 720% advance during the year. I've read that shorts lost $38B during '20 alone on their collective positions & short interest is way down. 32/

I happen to think the valuation is now so large to protect against a continued runaway price, particularly now that @elonmusk secured its entry in the S&P 500 by engineering 4 quarters of profits by cutting R&D, SG&A and thanks to environmental credits courtesy $GM & $FCA. 33/

Still, I’d never employ a large short position given unlimited downside and a max return of 100%. Margin is required against short positions. What appears to be a growing army of retail option traders, many employing sizable margin debt, is a recipe for disaster. 34/

Price and quality conscious investors get uncomfortable at times like these. I am extremely uncomfortable. I hope those that have no idea what they are doing heed growing and now very high risk and fully understand downside and what margin calls and maintenance margin mean. 35/

Many, many speculators will lose much and even all of their money at some point as this bubble breaks. Now is the time to reduce risk. You could feel badly for employees that were paid in non-qualified stock options and kept their shares upon exercise in the late 1990’s. 36/

When shares plummeted in the wake of the tech bubble the tax liability due on gain realized as income upon exercise was still due and payable, despite shares that were way below the exercise price. It was bad. Many lost everything but weren’t in a position to understand risk. 37/

Borrowing against Tesla (or any) shares and buying call options presents serious deliberately assumed risk. For perspective, a 92% decline takes the shares back to where they started 2020! With margin, it will take way less than a 92% decline to introduce wipeout. 38/

For those employing these strategies w/ other people’s money, may I direct you to ch. 4 of Security Analysis–Distinctions Between Investment and Speculation & ch. 1 of The Intelligent Investor– Investment Versus Speculation: Results to Be Expected by the Intelligent Investor. 39/

After a day of football, reflection on the year now gone, a glass (or two) of Bordeaux and a ribeye tonight, I’ll settle into the year-end letter tomorrow and may elaborate further on the margin debt issue, among others...In the meantime, Happy New Year everyone! Peace. 40/40 END

Math error in /38. It would only require an 88% decline in $TSLA to take the stock back to where it began 2020, not a 92% decline as written. Sorry for the confusion. Said decline implies an $80 billion market cap. Revenues are ~$30 billion.