This is a guest post and may not reflect the views of old school value
Congratulations to Tesla Investors
If you bought shares of Tesla in early 2013, and still own it, then first of all, you deserve a round of applause for having picked one of the biggest and ‘most-glamorous’ multi baggers of our time.
Kudos to you.
Your investment is already up from a low of $34 in 2013 to a high of $265 in 2014.
That’s more than 675% in just over a year. Even Warren Buffett would be proud of you.
Since it’s IPO in June 2010, Tesla was up as much as 1200% at it’s peak. Currently sitting at around 860%.
Tesla has been referred to as a “jockey stock” in past, with Elon Musk being the Triple Crown superstar jockey. A lot like how Steve Jobs was the champion jockey of Apple.
Similarly, it looks like there is nothing that can stop Elon Musk and Tesla, but it’s time to objectively analyze a few important concerns about the rise and rise of Tesla.
Previously an article on Tesla was posted on Old School Value titled Why Tesla is Like Apple Except the Valuation.
5 points were discussed
- Tesla has a crazy leader
- It’s a revolutionary product
- There’s a rabid fanbase
- Huge market size and potential
- Apple like in store experience
But what’s lacking is a discussion of fundamentals and future expected values.
Is This 1999 Again?
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It’s wrong to say Tesla is an automobile company. Being a super luxury car company is only it’s second identity.
Tesla is first and foremost a tech company within the automobile industry which is why I have no problems comparing Tesla to companies like Facebook, LinkedIn, Netflix etc.
So when I saw the news that Facebook was buying WhatsApp for $19B as well as the exponential pattern in Tesla’s stock chart, it’s feeling like 1999 all over again.
The stock price has absolutely no regard for current profits or sustainability and you can credit Tesla’s meteoric rise to 3 things.
- Projections on future profits
- Projections about the success of Tesla technology, cars and now Gigafactory.
- Eon Musk’s glamour quotient
A Quick Valuation Check
A way to perform a sanity check is to do what Old School Value does. Using reverse valuations to determine what the market expectations are.
Stock prices are simply based on the supply and demand of the public market. So what better way to get a grasp of where the stock stands than to reverse engineer the stock price?
Per analyst estimates, Tesla is expected to earn close to $1.78 EPS in 2014-2015.
This translates into a multiple of more than 100x the current market price. It’s tough to value a company like Tesla where projected growth is in the 80% range. How to do you value a stock with such high growth? What happens if growth slows down just a little bit.
Obviously, current financials is not be a suitable indicator of the future here.
But let’s see what we can come up with.
To find out what sort of growth expectations the market is placing on Tesla, use a reverse valuation.
You do this by adjusting the growth rate to match the intrinsic value to the current price.
From this, the Tesla has expectations of 95% growth baked into the stock price already.
Inverting the calculation shows a sobering picture for sure.
Now take a look at what a simple drop in growth will do to the valuation.
Here are the two basic inputs I’ll be using.
- EPS Growth of 80%
- EPS of $1.78
80% is still a huge growth number, but look at the difference in the implied intrinsic value. If high flying growth stocks miss their growth targets by even the smallest amount, it has a massive effect on the value of the stock.
A point to note is that the Graham valuation model errs on the optimistic side.
There’s no fundamental rationale which can justify Tesla’s share price.
Tesla is no General Motors, Volkswagen or Toyota
Another point bullish investors are missing is that Tesla is not General Motors, Volkswagen or Toyota.
Those companies offer a full range of automobiles, from luxury cars to mass market ones.
That’s not Tesla’s business model or plan.
So believing that Tesla will reach the size and market capitalization of these automobile giants is looking for fool’s gold. It’s not possible unless and until a black swan event like sudden exhaustion of fossil fuels happens.
Note: You can’t rule out the possibility of big automobile players buying out Tesla to prop up their electric car developments and win the so called ‘electric-car-race’. But this will be a rare event. I don’t see Musk even willing to play with the idea of selling his company.
According to the father of value investing, Benjamin Graham, typical no growth companies are valued at a Price-to-Earnings multiple of 8.
But in general, a company having high growth in the the near future is valued at a P/E Ratio of 20 to 25x.
So in Tesla’s case, only 3 things are possible related to its stock price.
Scenario 1: Tesla is able to increase its earnings dramatically to justify a multiple greater than 100x.
Effect: Share price continues making newer highs
Scenario 2: Tesla is unable to increase its earning at such a fast rate. This would lead to big time contraction of P/E.
Effect: Share price crash
Scenario 3: Tesla is able to increase its earnings at an above average rate and P/E also contracts to reach a stable state.
Effect: Maintains the price at current levels.
A few months back, CEO Elon Musk made a statement that his company’s stock price “is more than we have any right to deserve.“
The stock price that we have is more than we have any right to deserve. I’m not going to sit here and say we deserve every penny of that. I think it’s more than we have any right to deserve.
We’re going to do our best to fulfill the expectations of investors and I think in the long-term that stock price is going to seem fair. It’s difficult to predict where it goes in the short or medium-term but I do feel good having the company achieve that value and more in the long term.
For a long term investor, a five year period is long enough to judge whether a company can deliver returns or not.
A Basic Way to Calculate What Tesla’s Stock Price Should be in 2019
Here’s another basic way to do a valuation of Tesla.
Tesla is expected to make $1.78 per share and according to analyst best-case forecasts, around $5.50 per share in the next five years.
This works out to be an earnings growth of 28% for the next five years. Far below the 80% that I used earlier.
Now consider that all stocks will eventually trade towards the mean.
Over the next five years, Tesla’s P/E can’t sustain it’s current level over 100x.
Assuming that Tesla’s valuation stabilizes to levels in accordance with its earnings growth rate, it can be safely said that the company should command a multiple between 25 and 30.
Using the EPS of $5.50, the stock price should range between $137 and $165.
This is still about 25% lower than the current market price and supposed to be the EPS five years in future.
If you think a multiple of 25-30 is too low, I back calculated some earnings per share figures and required growth rates which will help you see the crazy expectations placed on Tesla.
The yellow cells highlight the required growth rate in earnings for 5 consecutive years at various P/E levels. Numbers like 44%, 38% and 33% growth isn’t going to last forever. Even fast growing tech companies slow down.
As Tesla gets bigger, the law of large numbers is going to catch up. The green cells represent a more possible and achievable growth rate.
But the problem is that at such growth rates, the P/E has to contract to low two digits which brings the intrinsic value down to $100 – $125 after 5 years.
Hogs Get Slaughtered
If you got in the IPO or bought a few years back below $60, then you deserve the gains.
You foresaw the potential and you have huge gains as proof.
But… hogs get slaughtered.
Take some money off the table because you can always come back later when prices are more rational and Tesla’s business is less glamorous and more business-like.
It is highly unlikely that triple digit multiples are sustainable. You certainly don’t want to be doubling down at this stage.
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