Will Danoff: What I Got Wrong About Tesla

Amy Arnott: Hi, I’m Amy Arnott, portfolio strategist with Morningstar. I’m here with another excerpt from our conversation with Will Danoff at the Morningstar Investment Conference. In this excerpt, he’ll talk about the importance of earnings growth and why he thinks investors should avoid companies that don’t have profits.

Why Investors Should Avoid Unprofitable Companies

Arnott: You talked about mistakes and how they’re sort of inevitable. I know you have referenced Tesla TSLA, the fact that you sold part of your position back in 2017 and 2018, I think. Is there anything that you would highlight?

Will Danoff: I think, for me, the biggest mistake with Tesla was when they opened the factory in Shanghai successfully, earlier than schedule, under budget, I think, but they were able to sell the cars at Western prices when they had a Chinese cost of goods sold. They were very high margin. I forget, it was the third quarter, the fourth quarter of 2019, maybe; they had a blowout quarter. And you’re talking about if the stock has doubled, we haven’t missed it. They report a good quarter, stock goes up a lot. And I was like, “I can’t buy this up 20%. I’m going to wait.” But that was the moment when earnings estimates started going up. I mean, the one lesson we haven’t really talked about, and why I think Contrafund and Fidelity have done so well, is this notion that stocks follow earnings. The earnings per share and the stock price are very highly correlated.

In that case, and every quarter, Reg D or not, Reg FD or not, you get a report card. Company growing earnings 20%, growing earnings 10%, growing earnings 40%. You can decide which ones you want to play in. But I hesitated, and I was just like, “This was a blowout quarter, but I can’t pay out aftermarket or the next day.” But it was the beginning of a six- or eight-quarter explosion in earnings, and I kind of missed it. A lot of growth managers either jumped on or were already involved, but that was a big mistake. That was a miss. And I knew the company, and I shouldn’t have missed that one. I don’t know, just other mistakes in general.

I mean, going for the long ball, the corollary to stocks follow earnings, I used to work next to a great investor named Jean Park, and Jean used to say—I think she was the Morningstar Manager of the Year one year, or maybe she wasn’t—but avoid unprofitable companies.

So, if I have any advice to the Morningstar community, it’s to be very careful of unprofitable companies. Maybe you miss a double or a triple or quadruple, but if you wait until they’re profitable, that’s a lot safer. But it’s hard because Steve Wymer, who’s done a great job for us in growth and the growth fund, unbelievable record, unbelievable investor, has done a lot in biotech. Biotech companies are unprofitable until their drug is approved, and then they’re very profitable.

Arnott: Yeah. They’re burning through cash.

Danoff: Yeah. There are really no easy rules to success.

Arnott: Right.

Danoff: But “stocks follow earnings” is a good one. In general, you’re wise, especially if you’re not a professional, to avoid unprofitable companies. And the corollary is, oh my God, the exciting new blowout long shot. The Hail Mary passes are often difficult for the shareholders.