3 Types of Investors Who Should Avoid SpaceX and Tesla Stocks as the Companies Explore a Potential Merger

On Space Exploration Technologies' (NASDAQ: SPCX) third-quarter earnings call on Oct. 20, CEO Elon Musk revealed that the company and his other megacap, Tesla (NASDAQ: TSLA), are contemplating a merger.

Not surprisingly, many investors have taken a strong interest in a possible SpaceX-Tesla merger. The combined entity would be one of the world's largest AI companies.

Although many investors would likely own stakes in that company, such a stock is not suitable for everyone. In particular, these three types of investors should probably not rush to buy it.

Image source: The Motley Fool.

1. Novice investors

Even for those who know nothing about investing, both SpaceX and Tesla might look like attractive choices on the surface. Both are growing their revenues thanks to technologies that increasingly interest the public, and Musk's past successes add to their appeal.

However, most investors do not own individual stocks. Instead, they tend to own long-term passive mutual funds and exchange-traded funds held in their retirement accounts. That is a sensible strategy, particularly for investors who don't have the time or willingness to dig into the details of individual businesses' competitive advantages, risks, and financial metrics. Many of these funds may include Tesla and SpaceX among their numerous other holdings.

Moreover, if one wants to learn how to invest in stocks, most experts recommend starting with companies that have well-known brands, solid balance sheets, and long track records. SpaceX and Tesla are both well-known, but SpaceX doesn't even have a full year under its belt as a public company, and Tesla only went public in 2010 -- that's not a terribly long track record either.

Moreover, objectively speaking, these companies' financials may not be the easiest to understand. Blue chips such as Home Depot or Chevron, which have existed for decades and operate in more straightforward businesses, may make better sense as one's first stock picks.

2. Risk-averse investors

Another aspect of investing that both novices and veterans alike must account for in their choices is their risk tolerance.

Risk-averse investors would rather accept less growth potential in exchange for a lower chance that they'll actually lose money on a stock. As such, they are better advised to buy slower-growing stocks in stable businesses that are less likely to fall in the long run. Even in bear markets, they tend to decline less than cutting-edge tech companies that get valued heavily on the future potential, and those slow-and-steady stocks often pay dividends.

In contrast, risk-tolerant investors are willing to accept a markedly higher possibility of stock price declines if it increases the likelihood of rapid growth. Almost by definition, this requires them to be comfortable holding on through significant short-term ups and downs. Not surprisingly, SpaceX and Tesla typically attract this type of investor despite being among the largest companies trading on the market.

Additionally, both are bets on the artificial intelligence megatrend. Assuming their AI technology thrives in niche markets, either of their stocks or the combined entity could earn considerable returns. However, failures in this area could mean investor losses. Moreover, since both trade at extremely high and speculative valuations, investors today face a greater risk of overpaying for these stocks.

Not all investors will feel comfortable with these risks. Those who don't should probably not own these companies directly.

3. Extreme growth investors

Given the other two reasons to not own these stocks, telling some growth investors not to buy SpaceX or Tesla does not seem to make sense. Tesla has historically experienced impressive periods of rapid growth in its publicly traded history, and both appear well-positioned to outperform the S&P 500.

Unfortunately, investors also must temper their expectations given the companies' sizes. Growth investors have likely read stories about how those who invested a few thousand dollars in Home Depot or Amazon around their IPOs and held on now have positions worth millions.

The difference is that Home Depot or Amazon were small-cap companies at the time of their IPOs. At this point, Tesla and SpaceX are megacaps. Currently, Tesla's market cap is about $1.5 trillion, while SpaceX's is at $2 trillion -- just about where it was early on the day of its June IPO.

This means that the combined company's size would be at least $3.5 trillion. A 100-fold gain in such a stock would take it to $350 trillion. Considering that no company has yet reached $6 trillion, and the entire value of the U.S. stock market is around $75 trillion, even a 10-fold gain would seem hard to imagine.

Admittedly, AI development is driving rapid growth. If a combined SpaceX and Tesla succeeds, a $10 trillion or even $20 trillion market cap is possible in the foreseeable future. Still, a $20 trillion market cap would be close to a sixfold gain. That would be impressive, but it's still well short of the 100-fold or more return potential that extreme growth investors might seek.

Investing in the combined SpaceX and Tesla

Although a combined SpaceX and Tesla holding could be desirable, that prospective stock would not be suitable for everyone. Both companies are likely to be among the top AI companies. This could mean they will outperform the market regardless of whether the merger happens.

Nonetheless, before buying such a stock, one has to know what kind of investor they are. If they are not knowledgeable, cannot tolerate significant risk, or have extreme growth expectations, they may not want to buy shares of this prospective future company.

Will Healy has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon, Chevron, Home Depot, and Tesla. The Motley Fool has a disclosure policy.