Elon Musk’s Tesla (NASDAQ: TSLA) has been a subject of controversy among investors as they try to ascertain whether it makes sense to invest in the electric car maker. For starters, the stock currently commands a whopping $28 billion valuation and trades at 8.1 times sales with a forward P/E of 104. Since the company is on track to sell just 80,000 cars annually, the general consensus is that the stock is priced for growth and therefore it still makes plenty of investing sense.
However, should investors continue paying a premium for the shares based solely on the expected future growth? Both Facebook (NASDAQ: FB) and Alphabet (NASDAQ: GOOG) are also considered growth stocks and can come in handy to help us estimate whether investors are actually overpaying for the so called growth.
On one hand Alphabet grew revenues at about 14.6 percent CAGR for the past five years while Facebook registered about 37 percent CAGR over the same period. Comparing this with Tesla’s 81.7 percent CAGR revenue growth over a similar period, it appears to be a no brainer that the company should indeed be valued higher than the two based on its growth prospects.
In terms of profit, Alphabet has posted a 10.5 percent CAGR over the same five year period while Facebook has delivered a 28.8 percent CAGR over the same period compared to Tesla’s 71.9 percent CAGR. To the casual observer, these comparisons have the potential to mislead due to the fact that we have to factor in that Tesla is working off a small revenue base (about $200 million) compared to the other two revenues which averaged billions.
Furthermore, making year over year comparisons reveals that things aren’t all that great at Tesla. While Facebook’s growth has been accelerating and Alphabet’s has relatively remained the same over the past five years, Tesla’s growth has been slowing and since the EV maker has not yet been profitable, this is a major red flag.
Is Tesla’s stock price justifiable?
Looking at Tesla’s valuation with respect to other automakers illustrates just how much the company needs to do in order to justify its valuation. Ford (NYSE: F) with an enterprise value of $42 billion and General Motors’ (NYSE: GM) $45.6 billion sold about 6.6 million and 9.9 million vehicle respectively last year. Compared to Tesla’s enterprise value of $36 billion with sales of just 50,000 vehicles it is pretty evident that there is a mismatch in valuation that should give investors pause.
For Tesla to justify its valuation and trade at the same EV/S ratio as both General Motors and Ford, we estimate that it would need to grow its vehicle sales at a 28 percent CAGR over the next 20 years which is highly improbable considering that its current sales grew by about 26 percent year over year.
In short, Tesla would need to make sales of at least 6.6 million vehicles annually so as to justify its valuation which would be a tall order taking into account the fact that there were 17.8 million vehicles sold in the U.S last year. In addition to this, a recent report from The Financial Times revealed that Apple (NASDAQ: AAPL) had approached British automaker McLaren Technology Group for a strategic investment or a full takeover signaling that the tech company is indeed serious about developing its own EV.
McLaren is valued at between $1 billion and $3 billion and considering that Apple has more than $200 billion in cash, an acquisition of this size would be too easy. If the reports are proven to be true, this could put further pressure on Tesla’s EV business as the competition will intensify exponentially.
From this perspective whether an investor is comparing Tesla to tech or automotive companies the harsh truth is that the growth priced into the stock is virtually impossible to realize. Luckily for Tesla and its proponents, the company isn’t a one trick pony.
Vertical integration could be leveraged to boost the bottom line
Tesla recently announced plans of doubling down on their growth goals and it seems that vertical integration could help boost the bottom line. Think of it this way. Tesla is far more vertically integrated than any other car manufacturer considering that it develops its own software, hardware computers and are now in the process of building the world’s largest gigafactory.
This bodes well for the company as it could provide it with other options of getting diversified revenue streams. For instance, since Tesla is far ahead of anyone else in the race to bring battery factories online, it could emerge as a supplier for the batteries needed to run EVs which reports estimate will comprise 30 percent of all new car sales by 2040.
Another speculative scenario is one where Tesla licenses out parts of its software, in particular the self-driving feature to other manufacturers. Although this feature has been surrounded by some controversy after causing accidents, it has proven to work well as long as there is a bit of human input.
Autonomous vehicles have been touted as the future of transportation and with Tesla also leading the pack here with mostly successful results as shown by its vehicle’s capability of automatically changing lanes on the highway, the opportunity here shouldn’t be underestimated.
No matter how you look at it, Tesla’s shareholders are overpaying for growth and lack a margin of safety for their investment. Though the outlook for EVs demand is positive, the competitive environment is growing tougher each passing day as new automakers scramble to develop and launch their own vehicles for the mass market. This will make it harder for Musk’s company to realize its long term goal of selling millions of vehicles and becoming as big as General Motors or Toyota.
The main takeaway for investors here should be that – indeed Tesla could break even if it manages to sell 10 million cars but that could take years. It would be better to bet on the company’s other projects such as the gigafactory in development as the catalysts that will drive the company to profitability.