Is Tesla’s Valuation Justified and What is Next for the Company’s Stock?
By Daniel Moore, Analyst at the University of Bristol Politics Society
At the time of writing, Tesla’s stock price is $609.99, giving the firm a market capitalisation of $578.21 Billion (1). Between 19 February and 18 March 2020 the value of Tesla’s equity fell by 60.63%, but since then has risen by approximately 744.39% (2).
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For anyone unfamiliar with Tesla’s operations, it is an electric vehicle manufacturer and battery producer; the Chief Executive Officer of the company is Elon Musk, and the majority of revenue generation (51.5%) comes from sales in the United States (3).
Rather than immediately rushing to criticize Tesla’s exceedingly high valuation data and market fundamentals, it may first be prudent to analyse the evidence that prominent institutional investors utilize when attempting to justify the value they attribute to Tesla stock.
Climate change is a real and concerning issue that has been imposed on governments, firms and consumers alike in the contemporary world. Since carbon emissions have been identified as a large contributor to climate change, diesel and petrol-fuelled vehicles have come under the scrutiny of progressive government policy. The UK government has already declared an outright ban on the sale of new petrol and diesel vehicles from 2030, and since Joe Biden is President-elect the US will likely follow suit with a similar policy in the coming years (4). Oil is a finite resource, and its supplies are being exhausted at an alarming rate. Therefore, alternative energy sources are in high demand globally. The underlying cost of the technology used when producing electric vehicles is falling at a rapid pace and output is scaling up.
Electric automobiles present an appealing solution to the issue of carbon-emitting transportation and Tesla is undoubtedly at the forefront of this technology, being a distinct market leader in the sector. Due to the expeditious expansion in the EV industry, there are now predicted to be approximately 42,057,000 electric car sales in 2040 with hybrids and fully voltaic vehicles comprising 38% of total market production (5).
Tesla’s most recent quarterly production and delivery report, a statement depicting trading statistics decomposed by vehicle model from July 2020 to September 2020, claimed the company generated an output of 145,036 cars (6). To estimate an annual output we can multiply this figure by 4, giving 580,144. Total EV vehicle transactions in 2020 are forecast at 3,179,000 (7). Therefore Tesla’s current market share in electric vehicles amounts to 18.2%. Assuming that Tesla can maintain its dominance, by 2040 they could be looking to produce roughly 7,570,260 vehicles. However, China accounts for 61% of present-day EV purchases, only 12.1% of Tesla’s revenue comes from China. Consequently, when the proportion of Chinese to Western consumers in the EV market experiences significant reductions, as it is speculated to do so by as much as 30%, Tesla’s market share may well rise (8).
Tesla’s post-tax profit for 2020 is reliably expected to be around $2.5 billion (9). If they can keep that profit margin consistent up to 2040, there is a strong possibility it may increase due to improved operating efficiency and economies of scale, post-tax profit for 2040 could stand at roughly $32.7 billion. Earnings per share would then rise to $34.5, giving a PE ratio of just 18.3 calculated at today's price.
Taking into account Tesla’s exceptionally low debt and opportunities for continued growth, profitability and expansion beyond the period in question, the premium does not look entirely unreasonable. Relative to another car maker such as Ford, Tesla’s price seems fairly appropriate and cheap. Ford has ridiculously high levels of gearing, limited growth prospects and negative EPS, it trades on a PE of approximately 10, however, this will likely increase as profits are forecast to fall (10). Comparatively speaking, Tesla is a significantly better investment taking fundamentals into consideration, despite its colossal market capitalisation.
Another attribute of Tesla that is easily overlooked is the ingenuity of its board of executives. Elon Musk is a profoundly intelligent engineer and businessman. He co-founded X.com in March 1999 and then, subsequent to a merger with Confinity, developed PayPal, a company now worth $260 billion. In addition to this, he has been the product architect of Tesla since 2008, contributing to the design of their lithium-ion batteries and vehicle structures.
Realistically, solely focusing production on electric vehicles over the next decades will yield sizeable returns. However, these returns alone will not, in my opinion, be enough to propel the Tesla stock price to the trillion-dollar ceiling. It is almost a certainty that traditional car manufacturers will adapt production to EV in the coming decades, reducing Tesla’s grip on market dominance. Whilst vehicle sales will always contribute substantially to Tesla’s profits in the short and medium-term, over a longer period I would expect their margins to reduce slightly because of competition, even with economies of scale and cost reductions. The real value in Tesla’s premium lies elsewhere, outside the automotive industry. The unique design of their lithium-ion batteries provides unlimited opportunities to branch out into other areas of conventional technology. Heating, ventilation and air condition provide great examples of old tech that could be optimised with efficient green energy sources. Musk has even hinted at movement into the car insurance market to improve margins on vehicle sales (11). Autonomous vehicles, robotics and AI technology are other sectors that could utilize the technology. There are huge possibilities for Tesla in the future, but before it warrants a market capitalisation of $1 trillion it needs to diversify, that is a common theme with big tech, but at the moment Tesla is an exception as it relies solely on electric vehicles.
It must be acknowledged that a lot of uncertainty surrounds the EV market predictions due to the long duration of time over which they are forecast. A great degree of error is possible in either direction regarding car production and sales profitability forecasts. Consequently, I would not recommend buying Tesla stock at its current price, the investment is far too speculative for me. However, if the board indicates that diversification out of vehicles is an opportunity or the stock price falls in the near term to offer more value, I think that Tesla would be a great company to own for the next 50 years and could definitely see it surpassing the trillion-dollar mark.
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1. Nasdaq (2020) Tesla Inc. Common Stock: https://www.nasdaq.com/market-activity/stocks/tsla
2. Yahoo Finance (2020) Tesla, Inc. (TSLA): https://finance.yahoo.com/quote/TSLA/
3. Sharepad (2020) Tesla Inc. (Company): https://engine-5.sharepad.co.uk/SSWeb/app.do
4. Pickard, J. and Campbell, P. (2020) ‘UK set to ban sale of new petrol and diesel cars from 2030’, 15 November 2020: https://www.ft.com/content/5e9af60b-774b-4a72-8d06-d34b5192ffb4
5. Wood Mackenzie (2020) Electric car forecast to 2040: https://www.woodmac.com/our-expertise/capabilities/electric-vehicles/2040-forecast/
6. Tesla (2020) Tesla Q3 2020 Vehicle Production and Deliveries: https://ir.tesla.com/press-release/tesla-q3-2020-vehicle-production-deliveries
7. Wood Mackenzie (2020) Electric car forecast to 2040: https://www.woodmac.com/our-expertise/capabilities/electric-vehicles/2040-forecast/
8. Wood Mackenzie (2020) Electric car forecast to 2040: https://www.woodmac.com/our-expertise/capabilities/electric-vehicles/2040-forecast/
9. Sharepad (2020) Tesla Inc. (Forecasts): https://engine-6.sharepad.co.uk/SSWeb/app.do;jsessionid=7DDF8A092E5D6DAC71432CEBD9DFE98B
10. Sharepad (2020) Ford Motor Co (Forecasts): https://engine-6.sharepad.co.uk/SSWeb/app.do;jsessionid=7DDF8A092E5D6DAC71432CEBD9DFE98B
11. Graffeo, E. (2020) ‘Tesla could soar another 300% as the company expands its tech outside the auto industry, a prominent VC investor says’, 7th December 2020: https://markets.businessinsider.com/news/stocks/tesla-stock-price-soar-gene-munster-loup-ventures-auto-industry-valuation-2020-12-1029869745