I Can't Justify Tesla Motors' Valuation

Tesla Motors (NASDAQ: TSLA  ) CEO Elon Musk thinks the company can produce 21,000 cars this year. Though this is certainly an impressive achievement, it pales in comparison with the 500,000-vehicle production rate Musk recently told Bloomberg he thinks Tesla can achieve at some unidentified point of time. Easier said than done. The scenario is definitely probable if Tesla really can introduce an electric vehicle in the $30,000 range, as Musk has suggested the company can do in as little as three to four years. Though it's a big what-if, it's fun to speculate exactly what kind of money the company could be earning if this scenario came to pass.

Fudging the numbers
Producing 500,000 cars per year, Tesla could earn about $880 million in operating income annually. That means at today's price, Tesla could be trading at just 15.7 times the company's earnings potential at a 500,000-car production rate. Comparatively, Ford trades at 10.6 times operating income.

I arrived at 880 million in operating income by making several assumptions:

  • Tesla sells 500,000 cars per year.
  • Tesla will eventually sustain a gross margin of at least 25%.
  • Zero-emission-vehicle credits will cease to benefit Tesla's top line.
  • Average selling price will decline to about $40,000.
  • Revenue from development services will grow in proportion to automotive sales.
  • Operating expenses will decline to 30% of revenue (still about three times higher than Ford's) as the company scales its operation.

Obviously, this model has been drastically simplified, and estimating something this far out into the future has very poor chances of being even close to correct. Even worse, I have no timetable for when Tesla could reach 500,000 cars annually. But the exercise does add some perspective.

Is it realistic?

Though Tesla may be able to attain a 25% gross profit martin by the end of 2013 on sales of the Model S, is it likely the company can sustain such an impressive gross profit margin when it starts selling a car in the $30,000 range? That's tough to say -- $30,000-$40,000 is a huge drop from the Model S prices ranging from about $70,000 to $80,000 and about $95,000 for the Model S performance

So taking things down a notch and estimating a 17% gross profit margin, close to Ford's first-quarter outcome, Tesla trades at just 25 times estimated 500,000-car production rate operating income.

Twenty-five times future operating income doesn't sound too bad for a growth stock, but there are just too many uncertainties involved in this math. When you find yourself fudging the numbers to estimate an outcome, projecting turns into pure speculation.

Projecting that Tesla can maintain 25% gross profit margins begins to seem like financial suicide when you consider the investment power at the disposal of some of the big names in the auto industry. As Fool contributor Daniel Miller recently said, "Those who think that Tesla is the future of the industry may be correct, but those same people often think that juggernauts like Ford, General Motors, and Toyota will simply roll over and die -- which I believe to be very foolish."

And how can we be certain Tesla will reach an annual production rate of 500,000 vehicles someday in the future, anyway?

At today's prices, Tesla stock is for speculators
Though I wouldn't sell shares of Tesla if I already owned them, I definitely wouldn't buy them today either. Sure, Tesla has a good chance of growing into a very large addressable market. But a significant portion of this opportunity is already priced into the stock. For now, I'll watch on the sidelines, and it won't bother me a bit if I miss out on big gains -- the risk isn't worth going for the home run.

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Read/Post Comments (9) | Recommend This Article (4)

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  • Report this Comment On July 20, 2013, at 1:17 PM, hunter3203 wrote:

    Good article and it brings some reality concerning Tesla's valuation. It will probably be a while before Tesla's stock price reflects reality though. There's just too much hype out there now and enough people willing to buy at any price.

  • Report this Comment On July 20, 2013, at 1:34 PM, drax7 wrote:

    Just read Ford and GM are building rockets to launch space shuttle like space ships into orbit. After they succeed , they also plan to build a best ever rated car by consumer reports.

  • Report this Comment On July 20, 2013, at 1:36 PM, jamesdan567 wrote:

    As usual the author is wrong. You lack 40 years of experience in the markets. I don't. To value Tesla is simple. Do your quantitative analysis, come up with a value. Goldman seems to think that's around $58 per share, so I'll use that.

    Then take yesterday's closing price ($120) and imagine the closing price if Elon decided to leave Monday morning. In that impossible event, the stock would go to about $60. Some would say less, or more, but $60 seems reasonable to me.

    So there you have it. $58+$60 = $118. Is $120 a share justified? Yes, without a doubt. $120 a share does not factor in any qualitative benefits to the stock, except that the best CEO in the world is running the show.

    By the way, Elon would not get into the business to sell only 500K units a year. He just says that because if he said a higher number, people would interpret that to say he's going to build another factory. Of course, since Tesla bought 1.5 million square feet of land this week, I suppose they are thinking about it. Or do you think its always going to be a test track?

    Given the value of qualitative factors, the stock should be above $200. Tesla has 40% of the US EV market right now, and this stay steady as they grow. They have the world's best EV power train, its so good that Toyota and Mercedes buy it from them. Not too mention, revenues are growing rapidly. Since the EV is far less complicated to build or sell, Tesla's organic net profit margin will be at least double the ICE auto industry.

  • Report this Comment On July 20, 2013, at 5:23 PM, SteveTG3 wrote:

    I think you have the right method Daniel, i.e., what would be a fair valuation of Tesla based on scenarios 6+ years out, but I don't think you have the right calculations.

    I don't think in terms of 500K cars, but if I did... I'd accept your $40K per car. I'd expect 10% net income (after taxes, after everything). That comes to $2 billion in earnings, or $15/share. A p.e. of 25 implies a price of $375 circa 2021.

    Nonetheless, I actually agree with you that Tesla is actually more a hold than a screaming buy. I think scenario is 75% likely (conservatively). There's also a scenario where Tesla is troubled and delayed... I'd see the stock trading about $100 in that case. So I think a 2021 price target based on this waited average is $300/share. Fair price now $150 (doubling ones money in 8 years is just about market average). I don't want to buy at a fair price though... I want to buy at a bargain! 30% off sale, under $100 I'd advise buying. 50% off sale, under $75, I'd advise buying BIG.

    Notes re conservative assumptions: that pe in 2021 I could see being anywhere from 20 to 40. Nothing has been modeled for licensing IP to other manufacturers, or ancillary businesses (grid storage, battery swap charges), or what chess moves Elon sees we haven't even imagined. These potential extra goodies are a big part of why this stock is so fun to own.

  • Report this Comment On July 20, 2013, at 9:58 PM, TMFDanielSparks wrote:

    @jamesdan567

    Thanks for your comment. Elon Musk is certainly talented, and that's the reason we can even project that Tesla could get to 500,000 cars at some (unidentified) point in time in the first place. So his talent is definitely factored in to the projection. But you've actually pointed out one of the very reasons investing on Tesla is based on speculation. What happens if Tesla loses Elon? You think the stock price would plummet to $60.... that's not a risk I'm willing to take. And keep and mind. I think Tesla will likely do very, very well. But the stock is already priced for the company to do very, very well. And I also think there is a good chance that the company can do better than very, very well..... blowing away everyones expectations. But now... we are starting to speculate. Even if an positive outcome is likely, it doesn't mean it's a great investment. Because if something goes wrong, I could lose a lot of money.

    Because of the valuation, there is too much risk for me. Focusing on limiting losses has worked for many great investors in the past and I don't think I'm any smarter than they are, so I'll stick with their proven strategy.

  • Report this Comment On July 20, 2013, at 9:59 PM, Oseo wrote:

    Simplicity... The model S is, up to date, the best car ever built. Best performance, best for the environment, best range, best infrastructure, best interest of the consumer! The value of the stock reflects the value of the product which reflects the volume of the sales and the demand. In todays era of information, consumers can see through smokes and mirrors. Tesla's future encompasses the entire auto market share. Narrow-focused calculations, especially now, just wont do. Tesla is revolutionizing the auto industry.

    Auto executives in rich complacency is something that got the US auto market bailed from bankruptcy, a real shame. Now you have an innovative company that brings out an American product that not just exceeds, but blasts, through any global competitor... This is something that is amazing for America: the consumer, the economy, and perhaps more important, America's reputation in the automotive world. Tesla puts us back at the top baby! This is a time for recognition, celebration, and financial backing for the newcomer that has spent the last 20 years developing this option for us! The painful reality that is hard to swallow is that the auto giants didn't do this for us even though they had vastly larger resources to do so. Walk into small town America and you will find that, out of sheer national pride, they will buy American even if it is an inferior product - less reliable, less performance, less value. They look the other way. Well, now there is an option that everyone, in every country, can look at with pride about the US auto industry. This is about an educated American and international public that wants a high value in their product and for their environment. Just be thankful that a different country didn't come out with it first. Thank you Tesla! What you are feeling is the passion of an American public that feels alive when someone in our country comes out with something this awesome!

  • Report this Comment On July 21, 2013, at 12:44 AM, weaponz wrote:

    For the record, Musk said that they will reach a minimum of 25% gross margins by end of this year. Which means above 25% is also possible.

  • Report this Comment On July 21, 2013, at 11:02 AM, Oseo wrote:

    Tesla is Tesla, it's no one person. Elon attracted a team of very talented individuals over the past 20 years, and that attracted millions of supporters and consumers. It has a life of it's own. The founder of apple is not with us, yet his legacy continues - a legacy that goes beyond mere calculation of profits. The legacy is of unprecedented value. It's wrong to for financiers to grossly short-change Teslas exponential growth curve. They are only hurting the consumer, the Ameican economy, and our standard of living. The next time one of them say's something along the lines of "I don't think Tesla could be that successful and so their stock should have a lower price", ask them: what type of car did you drive to the office today? How does it compare to a Tesla? Then have them talk about projections for Tesla's future growth, profits, and stock value. Or maybe, just ask them to go test drive one. They might have trouble speaking at all afterward.

    This is no less than an attempt by old-money to take-out the investor support of a innovative, amazing, company, in order to drive down it's stock value and it's ability to use that cash to grow. Look at the suggestions from recent recent "analysts" that attempted to artificially de-vlaue Tesla. In seperate articles they went and again, artificially, asked the public for investment into "other" US auto makers. It's a betrayal of the American public.

  • Report this Comment On July 21, 2013, at 1:15 PM, saintmarket wrote:

    FB, AMZN and NFLX are also with high P/E ratios. Also with market capital larger than GM and F. But they are just like TSLA, companies with a brighter future. Taking this into consideration I wouldn't be surprise if TSLA reach a market capital of 50 billions with a P/E of 500.

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