THE BLOG
10/15/2013 01:29 pm ET Updated Dec 15, 2013

A Fire Sale at Tesla

Last week, I received an email from Tesla Motors that talked about an unfortunate event with one of its high-priced, award-winning electric vehicles. A Tesla Model S caught fire and everybody was safe, but it the video viraled out of control on YouTube. Also, the stock tanked and within a day, Elon Musk's personal wealth temporarily shrank. In LA we call these things "carbeques" but thankfully nobody was hurt.

As I read through the email, it called to mind how Warren Buffett handled himself during "The Great American Express Salad Oil Scandal." While this story is almost 50 years old, it bears repeating in these present times.

Here is what happened with the Tesla: An item fell from a truck while driving along on a freeway, bounced under the car and ruptured the armor plating that surrounded the front battery packs. The driver brought the car to a stop and firefighters put out the blaze. In an email that sounded a bit defensive, Tesla went into great scientific detail why things would have been far worse with a gas-powered car.

So what made this car fire different? The video of the burning Tesla went viral and for a 24- to 48-hour period and there was institutional discomfort that this car fire might be the shape of things to come. The stock plummeted and there was momentary doubt and confusion about the brand. In this case, Tesla stock reflected a very good year for the carmaker. Unlike Fisker, Tesla turned its first profit. The coupe projects a cool factor and the Model S, their sedan, is the Motor Trend Car of the Year and scored the highest rating ever from Consumer Reports. It is the top-selling "plug-in" in North America and its stock has quadrupled since the beginning of the year.

In the case of the fire, "a picture is a thousand words." Fires have been a concern with plug-ins and that danger will probably resolve itself as the industry matures. We all remember the Ford Pinto that came standard with an exploding gas tank back in the 1970s. The engineering failure plus the PR disaster harmed the Ford brand and ruined the model. Tesla stock dropped roughly 8 percent on the day of the fire (this includes a 2 percent drop in after-hours trading) but also earned a stock downgrade from one analyst who moved from "buy" to "neutral."

So is this good or bad news for investors?

This calls to mind "The Great American Express Salad Oil Scandal." During the early 1960s, a shady investor named Tino De Angelis ran a scam where ships containing salad oil were used as collateral for loans provided by American Express. However, he only filled the top of the drums with oil; the rest were filled with water. In time, De Angelis was discovered as a crook and his house of cards came tumbling down. American Express was left holding the bag to the tune of a $58 million loss, which in 1963 was a sizable figure, and consequently its stock fell by 50 percent.

However, as Warren Buffett looked around, people were still using their American Express card to pay for their business lunches, dinners, and airplane flights. The scandal had absolutely no impact on whether or not people pulled the green card out from their wallets. Buffett saw opportunity while others saw disaster. American Express took a black eye on a financial scandal but the organization was well-run and apart from this glitch, profitable. Financial markets, as a rule, react emotionally to any scandal and institutional investors unloaded their Amex stock. Buffett, always the bargain hunter, saw a good deal and went for it. For the price of $20 million, he owned 5 percent of the company.

In the next decade, Warren Buffett expanded his American Express holdings and today remains their largest shareholder. This was not new investment approach for Buffett -- he emerged from the 2008 financial collapse will another sweet deal, this time from Goldman Sachs. He turned bad news into a profitable experience.

The larger question, dear investor, is this: Do you feel that Tesla is a well-run company? Are they worth your investment? Do they fit within your risk parameters? I'd look beyond the star power of the C-suite and wonder if Elon Musk has spread himself way too thin. I'd also wonder if what might happen the day that tax incentives for plug-ins disappear from the tax code. If that becomes the case, the Tesla S becomes a very expensive car with glaring limitations. When that day arrives, can Tesla stand on their own two legs? If you feel the answer is yes, then you may wish to invest.

Here is the good news: During the 2012 presidential election, Mitt Romney ridiculed Tesla surrounding the half-billion-dollar loan from the government awarded from the Department of Energy. However Tesla has fully repaid the note, nine years ahead of schedule. In a world where carmakers like Tucker, Bricklin, and DeLorean crashed and burned up against Detroit's Big Three, Tesla appears to be holding its own. Elon Musk has done rather well for himself and has leveraged his PayPal fortune to fund his later ventures, chiefly among them Tesla and SpaceX, which successfully sent a private spacecraft to resupply the International Space Station.

There are roughly 150,000 car fires in the United States every year but his one struck a chord. The fallout Model S fire reverberated to the stock, which "took it in the chops." However, this is nothing new. When the first piston driven cars caught fire, there was equal concern from those who still favored the horse and buggy. In fact, if every car fire had the same viral impact of the Tesla S "carbeque," Detroit automakers would have gone out of business decades ago. Tesla's stock quickly rebounded but then a week later, it tumbled downward again. Perhaps a correction is in the cards since the stock has outperformed expectations. Again, the new price point could be a buying opportunity if it falls within your investment wheelhouse.

Even though the Nissan Leaf has sold the most plug-in units globally, Tesla has captured the imagination because of the founder's desire to meld luxury with sustainability to create a cool smart car. Since they have carefully rationed their output so that demand exceeds supply, their brand carries a cachet and they can still demand premium margins of roughly 30 percent. With their stock price heading south for the moment, it could be the equivalent of buying a great pair of shoes on sale.

In many cases, investing in the auto industry runs counter to value investing because every auto manufacturer has to spend billions reinventing itself on an annual basis. Last year's models become obsolete as next year's emerge onto the showroom floor. Since it takes up to 36 months for a new model to move from the initial "green light" to the first consumer purchase, senior managers will have to predict what the price of gas will be, what buyer sensibilities are, and how economic forecasting will impact their overall planning. That can be a bit of a crapshoot as opposed to companies like Coca-Cola, which has used the same basic formula to power their brand for over a century.

As the senior management of Tesla manages through this minefield, value investors might want to take a look to see if they can sustain their margins over the long term while they build out their fleet of cars. Up next will be the creation of a plug-in SUV, and that may well be worth a trip to their dealership. However, whether the stock merits a trip to your broker is something that you will have to decide on your own -- or with the help of an investment adviser -- to see if it will offer value for the long term.

Note: Mary Buffett does not own any Tesla stock.