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Here's Why Tesla's Stock Is Crashing

NEW YORK ( TheStreet) -- By all accounts, Tesla Motors (TSLA - Get Report)  reported strong third-quarter results, but when a company's stock becomes irrationally inflated relative to the actual financial performance, strong isn't strong enough.

Tesla's reported 5,500 vehicles delivered last quarter -- 10% more than guidance. Albeit short of euphoric prophecies, everyone's expecting more-than-perfect execution from a company building a reputation for delivering the unexpected. It's the euphoria surrounding the share price that is guiding me to warn investors to take some money off the table while the valuation is rich.

Tesla reported a 12-cent profit, well ahead of whisper numbers of 9 or 10 cents and slightly above Thomson Reuters 11 cents. That's where the problem lies, because as great of a company as Tesla may be (and few are disputing the quality of its product or leadership), there is no amount of financial mathematical gymnastics one could perform to arrive at the conclusion that the potential reward justifies the risk.

The saving grace for Tesla investors this week comes from the massive short interest. Short interest is the proportion of shares that have been shorted relative to the overall number of shares actively traded, known as the float. Normally, when a company is performing well and meeting expectations, the short interest is small, perhaps 2% to 5%.

Read: Twitter Won't Be a Facebook: Here's Why

For example, Ford's (F) short interest is about 2% of the float, General Motors (GM) has 7.7% and Toyota Motors (TM) is less than 1%. In comparison, Tesla's short interest is more than 25%, and that doesn't include synthetic shorting by large hedge funds. You can learn more about synthetic shorting from Tesla's Index Entry Is a Two-Sided Coin.

As investors, the most pertinent question to ask yourself before you place an order is, "What edge do I have over my counterparty?" In other words, what makes you smarter than the person who is selling (or buying) shares to you?

If you're a Ford, Toyota, or GM investor, the shares you own likely came from another investor selling their shares. However, if you're a Tesla investor, especially a recent one, there's an exceptionally strong chance you bought your shares from a large hedge fund borrowing shares to sell to you.

Are you confident you have done more homework and understand the landscape better than the brightest minds on Wall Street? Have you performed your due diligence to know historically what the odds of success are for buying a stock with an annualized P/E of more than 350? You know the hedge funds short-selling shares have. Do you have a quantifiable edge over your counterparty, or in the voice of Clint Eastwood, "Are you feeling lucky?"

I'm in a trading room, another trader makes a comment that Tesla is a good company, and two thoughts come to mind. The first was agreement that the company is even better than good; it's downright astonishing what they have done. The second is that I may buy a Tesla car, or stock in Tesla at some point, but not until I conclude I have more than luck on my side.

Read: Tweet This: Twitter's IPO Is Speculative

Final takeaway: Expect higher than market volatility in Tesla, but I'm not predicting it will crash overnight. Because short sellers cover their positions to lock in profit as a stock declines, even news of Ford, GM and Toyota more aggressively entering the electric powered vehicle space (and you know they will if there is a profit to be made) won't result in an absence of buying pressure for shares.

For investors, short sellers may save them from a quick descent off a cliff, but will likely create a painfully slow and steady decline in share price, not unlike a leaky sink faucet keeping you up at night.

At the time of publication, Weinstein had no positions in securities mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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