Why Tesla's recent stock rally has caught Wall Street off guard

For the past few years, Tesla has presented a pattern appealing to skeptics of the company's future - and investors who want to short the stock, or who are just Tesla bears.

The pattern has played out like this: Tesla misses its yearly guidance for deliveries. Analysts then note that Tesla isn't making any money, it's burning a lot of cash by trying to grow its business, competitors are multiplying, the electric-vehicle market is globally tiny, and CEO Elon Musk is stretched thin running Tesla and SpaceX.

The stock price slides, typically recovering only after some positive sentiment develops after first-quarter earnings are reported and shares start to look like a bargain. News events can also revive optimism - Tesla offers a new version of a vehicle or unleashes a software update, that type of thing.

The pattern hasn't been repeated thus far in late 2016 into early 2017. In fact, Tesla has been enjoying a nice rally. Shares are up about 10% since the beginning of the year and have risen nearly 20% over the past three months.

Caught off guard

That surge has caught Wall Street off guard as much as the automaker's third-quarter profit was a surprise. Morgan Stanley's lead auto analyst, Adam Jonas - one of the biggest Tesla bulls on the Street - has slashed his target price for Tesla from $450, but last week he upped it from a conservative $242 to $305 with Morgan's equivalent of a buy rating.

Jonas is hedging a bit - Tesla's peak stock price, reached in 2014 during trading, was $298. But Jonas has changed both his view of the carmaker's ability to launch its $35,000 Model 3 on schedule in late 2017 and his expectations that Tesla will be able to create a business out of car-sharing with the so-called "Tesla Network," which could be worth over $70 per share of Tesla. (Because it doesn't currently exist, it's worth zero.)

So Tesla is rallying at a time when it should be swooning, and the biggest Tesla bull is regaining his optimism.

Added to this is Musk's unanticipated connection to President Donald Trump. Musk has joined Trump's council of business leaders, and numerous market observers have pointed out that Tesla is an American company expanding production at both its California plant and its giant battery plant in Nevada, where it plans to create some 6,500 jobs.

In his note upgrading Tesla, Jonas outlined the bear case for the stock, which for his team takes the price to $50. Essentially, that case defines Tesla as a niche player with limited sales growth and that doesn't meet Musk's goal of delivering 500,000 vehicles annually by 2018.

Knocking down the bears

The more aggressive bear case for Tesla is that it's a cash-burning machine, devoid of reliable profits from its various lines of business - including energy storage and solar power, after the 2015 acquisition of SolarCity - with a distracted CEO and an inability to meet its own delivery targets.

Tesla is starting to knock down some of those criticisms. The company looked to end 2016 with more cash on hand than expected - a situation that CFO Jason Wheeler chalked up to increasing efficiency throughout the company. This has pushed back on the widely held belief that Tesla would need to raise more capital in early to mid-2017.

Profits could also become more routine, although it's unlikely they'll be predictable. It just depends on Tesla's ability to build, sell, and lease more vehicles. It also hinges on the company selling as many emissions credits as it can when it needs to. (Tesla can accrue a lot of zero-emission-vehicle credits because none of its cars produce emissions.)

Musk's job is getting easier

Finally, Musk's job at Tesla should be getting easier. He said that he and the company were in "production hell" with the fraught Model X SUV in early 2016, but he no longer has to sleep next to the assembly line. Tesla also hired Peter Hochholdinger from Audi to improve and accelerate production.

Musk is still the top guy, but he got the automaker to a place where he can relax about the Model S and Model X and focus more closely on enhancing Autopilot, Tesla's semi-self-driving technology, and getting the Model 3 launched on time.

And there's one other thing: Tesla is getting better at building cars.

The company has always built good cars - so good that Consumer Reports had to recalibrate its testing scale for the Model S. But Tesla is now plunging into a potentially significant manufacturing experiment that could be the first innovation in car-making since Toyota pioneered its vaunted Toyota Production System after World War II. Much of the experiment could involve widespread automation of Tesla's factories.

An example of how far Tesla has come in the past three years: Production has grown from about 30,000 vehicles in 2014 to 50,000 in 2015 to over 80,000 in 2016. As production speeds up, that "500,000 by 2018" goal has become more realistic. And remember, it was 500,000 by 2020 before Musk moved up the timetable.

Taken together, these improvements have started to rapidly undermine the bear case - more rapidly, it seems, than the bears expected.

The future is still full of challenges for Tesla. But at the beginning of 2017, it has started to get the Wall Street bulls back on its side.