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Elon Musk on How to Think About Tesla's Value

Tesla (NASDAQ: TSLA  ) shares are up 434% this year. Asking whether this run has gotten ahead of itself and shares are overvalued is important. It's also an open invitation to feel the outrage of shareholders tired of those who "don't get it."

Whose opinion should you listen to? That's up to you. But a few weeks ago, Tesla CEO Elon Musk shared his thoughts in an interview with CNBC. Here's what he said when asked about his stock's surge (emphasis mine):

I really feel like the valuation we've got right now is more than we have any right to deserve, honestly. I think we need to make sure we really, you know, knock the ball out of the park in the coming years. ...

The market obviously goes through these periods of exuberance and depression. In our case, our stock has a lot of volatility because it depends so much on what people believe our future execution will be. Our stock price is obviously far too high based on historical financials, or even on current financials, so the value is very much based on what the future cash flows will be like. So as that confidence waxes and wanes, we'll see big swings in the value of the company.

The highlighted part isn't new; many people have pointed it out. But it's still lost on analysts and investors who are tempted to compare Tesla's metrics to other car companies.

The standard response to those who say Tesla can't be compared with others is to suggest they are falling for the "it's different this time" fallacy that pops up during all bubbles. But as analyst Eddy Elfenbein points out, sometimes it really is different this time:

I'd say there's about 10% of stocks, maybe even just 5%, where fundamental analysis is totally useless. ...The reason is that conventional metrics don't work on unconventional stocks. If a technology comes along which changes the entire ballgame, all those ratios go out the window.

How should someone have valued Eastman Kodak twenty years ago? The stock was a long-recognized stalwart of American business. It was a classic Nifty 50 stock and it paid a good dividend. As late as 2007, shares of EK were over $30. While all seemed calm on the surface, the company was quickly being made obsolete. Today, a share of EK goes for three cents. The dynamics changed and just by following the numbers, you would have been left in the dust. ...

There's always some innovation going on somewhere that threatens to upend the entire game, and fundamental analysis won't see it coming.

Same with Tesla. And it was the same 10 years ago during the dot-com bubble. Valuing companies based on clicks and made-up metrics was wrong for most dot-com companies. Most looked (and were) insanely overvalued. But for a few -- Amazon, for example -- the crazy valuations were totally justified: Amazon now trades three times higher than it did in 1999.

But Eddy's point about this rule being applicable to 5% or 10% of stocks is important. And I'd say he's overdoing it there -- I'd put it closer to 1%. The problem investors run into is that it's hard to know 5% or 10% (or 1%) of stocks to apply this rule to. Is it easy to tell apart from Today, of course. Fifteen years ago, it wasn't nearly as clear. All we knew was that some company would do something enormous, and traditional valuation metrics wouldn't apply to those winners.

If you're into this style of investing, you just have to be aware that what you're doing is more akin to late-stage venture capital investing than what most consider to be traditional investing. The prospect of massive wins is mixed with the risk of horrendous losses. The worst thing you can do when investing in a company like Tesla is not realize that this is what you're doing. When a lot of investors evaluate the company using traditional metrics like the P/E ratio, many of them clearly don't. 

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Read/Post Comments (21) | Recommend This Article (53)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 05, 2013, at 10:41 AM, highgrowthcarson wrote:

    Yes -- I think even less than 1% -- the problem is the success of one of these companies inspires huge run-ups in the shares of many others.

    As an investor I tend to look for the small number that have real potential, knowing that no matter how smart I might think I am, will hit many losers. So far in my 20 years of investing have basically made all the money have made in three stocks -- msft, aapl and tsla. Hoping to make much more in tsla, but understand it is a huge risk from here. My evaluation says the potential justifies the risk, but if the stock doubles in the next six months, I'll probably have to get out.

  • Report this Comment On October 05, 2013, at 7:24 PM, Shiroto wrote:

    It sounds to me like Mr. Musk is saying that the stock is currently overpriced. I think Tesla is a fine company, I really like their cars, and I admire Mr. Musk and his team, but I personally can't persuade myself to buy at these prices.

  • Report this Comment On October 05, 2013, at 10:43 PM, BradApple wrote:

    At this stage of the game, P/E ratio is not the way to evaluate Tesla. What I don't understand, however, is how Amazon (a nearly 20-year old company) gets away without being evaluated on that basis.

  • Report this Comment On October 06, 2013, at 2:34 AM, Amar191 wrote:

    TSLA is momentum play. Eventually trading like NFLX (Dropped from $300 to $53), PCLN (Dropped from $990 to $6.3) and AMZN ($130 to $5.51). Eventually TSLA will drop to ~ $25 and if it shows great cash flow, it rise to $1600 but not within this decade. Musk is good innovator but takes huge risks on investment and like Bill Gates or Steve Jobs he is not concentrated on one company or new industry. People are using cars since 120 years with various energy sources. $80-$110K car is out of reach for many middle class Americans. Musk is just thinking machine, everyday new idea which may or may not be useful to car industry.

    Car market is crowded and many Asian and European companies are trying different options. If stock market is doing good every cult stock enjoys good rally. Even going up 4 to 10 times in value. Once it reaches climax, it will descend 4x rate it went up. Wait for quarterly report.

  • Report this Comment On October 06, 2013, at 9:25 PM, knyc wrote:

    1% may be true, but I think Tesla may tesla Tesla.

  • Report this Comment On October 07, 2013, at 7:00 PM, gogunth wrote:

    Tesla manufactures a unique auto which is far ahead of the competition. At the price charged there is a small percentage of auto owners who can afford it, and I would guess (not a good way to evaluate a stock) that the number of buyers will drop in the not too distant future. I would be very surprised if at the end of next year there are still waiting buyers, and the sales volume may well drop - not to mention that it would not be unusual if some new problems with the car could develop. I think it near impossible to make a valid determination of the stock value with all the unknowns. It is a gamble to purchase the stock.

  • Report this Comment On October 07, 2013, at 7:59 PM, BentMike wrote:

    I could buy some TSLA, but its stock will crash when the market takes its inevitable ~5 year drop. (Not saying this will have anything to do with the business of being Tesla.) I may go in then. I got some NFLX at $53, but I believed in them more, since they didn't really have any competition and the reasons for the drop were kind of silly and independent of their prospects.

    Want to bet there is not some fancy dancing going on in the major car companies right now? I will take that bet. I don't think the future for TSLA is quite as wide and free as many think right now.

  • Report this Comment On October 07, 2013, at 8:12 PM, Goldbugg wrote:

    If you bought TSLA early and made 400% congratulations. Time to take some money off the table and let the rest ride.

    If you are thinking about initiating a new position here I would suggest heeding Mr. Musks warning and wait for a "waning period of confidence", and with that, a substantially lower stock price. Because sooner or later it will come down, and when it does it will come down very hard.

  • Report this Comment On October 07, 2013, at 8:32 PM, taxrep47 wrote:

    After the battery problems last week and reviewing comments from the CEO, I took my profits. I will buy again when the market adjusts.

  • Report this Comment On October 07, 2013, at 9:55 PM, colleran wrote:

    I have invested in most of the 99.

  • Report this Comment On October 08, 2013, at 7:10 AM, hartdoc wrote:

    Amazon and Microsoft were affordable to a huge market place. At 80-100K TSLA currently has a much smaller market. Either TSLA or an unknown competitor will figure out how to build a serious battery powered car at an affordable price and when that happens the sky will be the limit.

  • Report this Comment On October 08, 2013, at 10:24 AM, kewlness wrote:

    Tesla for me is still too speculative. Part of my analysis is something Peter Lynch preaches - follow the earnings. Tesla is just now really getting into the market with a superior product against a group of entrenched juggernauts. There are still some potential problems I see with Tesla's superior product - lack of variety, still too expensive, and lack of infrastructure (like electric stations) within the American market. Just because a product is superior does not mean it will gain sizable market share.

    I have no position in Tesla but I am watching it to see if I want to open one or not.

  • Report this Comment On October 08, 2013, at 4:46 PM, ryanalexanderson wrote:

    Wow, I'm amazed. Ten comments so far, and no sign of the crazy "YOU ARE ALL IDIOTS, YOU DONT UNDERSTAND TESLA!1! MOTLEY FOOL SUKS" comments that usually flood Tesla articles!

    It really does make me wonder if it's just one guy doing the trolling - a couple years ago he was doing it for Sirius, more recently Tesla...if so, I wonder where he'll pop up next?

  • Report this Comment On October 08, 2013, at 4:48 PM, ryanalexanderson wrote:

    I hope it's BRK.A. That would be hilarious.

  • Report this Comment On October 08, 2013, at 4:57 PM, EquityBull wrote:

    If you can't justify a stock on some kind of future cash flow potential then it doesn't work. Confirmation bias tells us that if the stock keeps going up that means it confirms all estimates and judgements. This simply is not reality. Amazon which after 15 years and counting makes no money. As long as the stock goes up all must be great though.

    Tesla will have to ramp up their supply chain and sales to incredible levels at a speed that is almost all but impossible to justify its valuation here at this point in time. Sure maybe 10 or 15 years down the road, possible. That's a long shot bet though. Musk didn't reinvent the wheel. He is just powering a car with electricity. It's not rocket science. Any auto maker simply has to design a nice looking car instead of the stodgy looking Volt like cars and they will sell. When they do there goes Tesla margins. Also what happens when Tesla can't sell energy credits and consumers don't get a subsidy? I'll take a BMW M5 over the Tesla any day of the week. No range issues. No 20 minute stops to charge to 50%. But the stock is going up so that means the market knows best and all is good.

    Potbelly went up to almost a billion dollar market cap. Must be a great sandwich. Their financials don't warrant this nor does their own stated business plan of intended growth. But again the euphoria is present at this moment in time so keep buying as long as you think others will take your stock from you at a higher price. Fundamentals are largely not part of the equation.

    If DC screws up like I expect them to all these money losers without cash flow and balance sheets will fall the hardest. Buyers beware and know what you own.

  • Report this Comment On October 08, 2013, at 6:39 PM, sailrmac wrote:

    Go ahead and compare Tesla to Apple. They both have cost of goods sold.

    However, when you compare Tesla to Amazon, Priceline, Netflix, Microsoft, etc. you are being specious. These other companies have very close to no cost of goods sold for their products. Programming costs sure, but each additional Microsoft office disk took almost no time to print and no cost to duplicate. Thus huge additional growth did not require huge additional funding for that growth.

  • Report this Comment On October 08, 2013, at 10:30 PM, RobDFoolish wrote:

    Bla, bla, bla, Tesla overvalued, yatta, yatta. It very well may drop, just like any other stock in this volatile market a terrible governance. I got it around $100 and I have a stop-loss ready for 50% of my holdings since it is a volatile stock. However, sometimes, you gotta support something bigger than the (once) almighty dollar. Conceived, designed, and built in AMERICA, one of the few things in this world that is. Two out of the "juggernauts" have bankrupted in the last 5 years, or have we forgotten? Tesla is innovating from the ground up and they are doing it the right way. Perhaps they are overvalued using the standard model, but maybe that model just doesn't apply. If it does drop and level out, cool, I'll just buy more. Everybody hates Sirius, but I was in for several thousand at $0.25, Netflix at $25, and Apple at $88, sometimes you have to go with your instinct and forget the markets, that's how you get the 5 baggers and 10 baggers. Regardless, I'm supporting one of the few things this country actually produces anymore. Someday, when I'm all grown up, maybe I can even buy one to plug into my 8 kW solar setup. Bon chance mon amies...

  • Report this Comment On October 08, 2013, at 10:44 PM, drax7 wrote:

    Teslas battery pack, battery range, battery cost, battery charging all combined is a brilliant solution that gives them a significant lead. The lead is further increased by their supercharging stations.

    Not that the best car ever rating and safest car ever rating hurt.

    As they approach and exceed 25% gross margins, that will give them the cash flow for the next model.

    I expect model s and x will sell 100,000 cars per year, and that amounts to about a billion in profits.

    One billion times a p/e of 30 gives me a value of 30 billion sometime next year.

  • Report this Comment On October 09, 2013, at 12:53 AM, Sicb wrote:

    Read More Opinions and especially the company website reports... I disagree with the Analysis. Optimism is more precise when viewing data trends and financials from the Horse. Even Google seems to impress the facts analytically.

  • Report this Comment On October 17, 2013, at 2:21 AM, missoulamike wrote:

    Quite the optimist drax7, what happens when Tesla runs out of rich, PC libs to buy their vehicles.

    In most of the country Tesla won't fly. That's reality..

  • Report this Comment On October 17, 2013, at 2:33 AM, missoulamike wrote:

    100,000 per year drax and they can continue to milk the EVA credits in Cali. FYI Cali is the only state that provides this subsidy.

    That's just delusional thinking if you don't reside in Cali. They rest of the country lives in the real world.

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