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Why Tesla Deserves an Enormous Premium

By nearly every valuation metric possible, Tesla Motors (NASDAQ: TSLA  ) is grossly overvalued. Traditional valuation metrics are basically rendered useless in analyzing Tesla. The company's iconic CEO, massive market opportunity, and unreal execution give the stock rights to an intangible premium that is basically impossible to quantify. Like it or not, however, this vague, intangible premium is real. How in the world, therefore, can an investor decide at what price Tesla is a buy?

But why?
Investors can't deny the fact that certain companies simply persist in defying conventional valuations for decades (think Amazon). It makes sense that companies with genius-like management and market opportunities that seem to have no end would deserve an enormous premium. But where does this premium come from? Why does disruption deserve an intangible premium?

The answer isn't mysterious. It comes from confidence. Genius talent, exceptional market opportunity, and a record of bulletproof execution provide investors confidence in the likelihood of the best-case scenario. We could go even further: Factors like these provide confidence that the company can outperform the best-case scenario.

In 2001, very few thought Amazon would challenge Wal-Mart. Apple beat best-case scenarios time and time again, revolutionizing entire industries with the iPod and the iPhone, and challenging PCs with an entirely new category: tablets. Amazon and Apple didn't just match their best-case scenarios -- they accomplished the impossible.

So, how big of a premium does Tesla deserve?
Led by the indispensable Elon Musk, the company has eloquently positioned itself as the top-notch, purely electric brand of the future. Even more, it has arguably hedged its own success with its aggressive expansion of exclusive, superior charging infrastructure. This has given investors an unquantifiable confidence in the company's future. In fact, investors are so confident in the company that the stock is priced for successful mass production and adoption of its third-generation affordable car.

Tesla's current premium is unquestionably large -- maybe even overly euphoric. If Tesla meets the goals it has laid out for next year, the company could generate $1.2 billion in gross profit for the full year of 2014. That's based on non-GAAP gross profit excluding benefits from ZEV credits, assuming Tesla exceeds 40,000 vehicle sales in 2014 and maintains its fourth-quarter gross profit margin target of 25%. In other words, Tesla may be trading at 17.6 times an optimistic outlook for next year's gross profit. Comparatively, Ford and General Motors trade at about 2.9 and 4.7 times a reasonable guess for their 2014 gross profit, respectively.

So, back to the question: What kind of a premium does Tesla deserve? I'm not going to pretend to have an exact number for you. What I can say is this: It's enormous. But exactly how big? Who knows? Personally, 17.6 times an optimistic outlook for next year's gross profit left me too uncomfortable to continue holding, leading me to sell shares last month. If the stock sells off significantly, I may be interested again. Sure, that may never happen. But that's OK. Jumping in on so much uncertainty is not investing -- it's gambling.

This vagueness is the unfortunate nature of investing in disruptive companies with enormous growth prospects already priced into the stock -- there's a lot of uncertainty. But don't throw all reason aside and invest in the stock at any price just because conventional valuation metrics don't apply. Nor should you react in the opposite direction and never invest in game-changing companies. Instead, approach each disrupter carefully and decide on a premium you feel comfortable with. Do your research and use discretion.

Most of all, don't be afraid to let investing be an art and not a science. As long as you're buying great businesses for reasonable prices with the intention of holding for the long haul, the science of investing seems to take care of itself. The key term to be emphasized in the former sentence for Tesla investors is reasonable prices.

Disruption at Its Finest
Very few stocks qualify as industry game changers. But this particular stock is certainly one of them. Watch our jaw-dropping investor alert video today to find out why The Motley Fool's chief technology officer is putting $117,238 of his own money on the table, and why he's so confident this will be a huge winner in 2013 and beyond. Just click here to watch!

Read/Post Comments (12) | Recommend This Article (3)

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 09, 2013, at 11:41 AM, damilkman wrote:

    I think TMFHousel had a good perspective. Treat these kind of companies as if you were a venture capitalist. Your conventional valuation is thrown out the window. A VC understands they might get a lot or nothing. We have to have the same attitude with companies like that.

  • Report this Comment On October 09, 2013, at 12:40 PM, SteveTG3 wrote:

    Charlie Munger (Warren Buffett's long time partner) said "you cannot buy your thinking done."

    I think this is doubly important to bear in mind in the world of infotainment.

    Tesla can be valued. No matter how many times Cramer calls it a "cult stock", others pile on to call it that, and claim it cannot be valued, it can.

    It can be valued using the same basic metrics all value investors use... pe, growth rate, margins, cash on hand, debt ratios, etc.

    The difference with Tesla is that it has unusual visibility of a VAST COMPETITIVE LEAD 3, even 5 years into the future. So, the fundamental tools of the value investor are applied not simply to next years earnings, but to earnings several years into the future. To me that is a more compelling case for valuation, not less. I've done that. I've done eps estimates for 2018, 2020, 2025. Most visibly, I see eps of $14 per share in 2018. I think fair value now is $175 (I do factor in scenarios where execution does not hit that eps mark).

    But, please, do your own valuation as you cannot buy your thinking done!

  • Report this Comment On October 09, 2013, at 1:53 PM, agsimian wrote:

    Tesla's problems lie in sticking to closely to conventional wisdom. Those unremovable batteries are a curse and are packaged wrong. The car fire was the' proof in the pudding'. So far the big lawsuit hasn't come, but if the burning batteries had been able to be ejected, the car would have been saved as they stated that it should have been (the damage was bigger than they ever anticipated, just like the Titanic). Imagine going to the local 'filling' station and swapping out the batteries in less than a minute and who is going to pay for a car that has bad batteries when they represent more than half the value of the car?

    Tesla is small time and not viable for the mainstream. luxury novelty.. and so it the stock. It will never pay off in it's present mode.

  • Report this Comment On October 09, 2013, at 1:59 PM, agsimian wrote:

    I will change my opinion when they go to removable batteries (like at least 3) in a standardized form, lease the batteries and outsource them to one of the big oil companies like BP n(or one of their 'shell companies).

    With this Pelosi can get her GPS tracking for free.

  • Report this Comment On October 09, 2013, at 2:40 PM, drax7 wrote:

    Tesla, I anticipate will sell 50,000 model s in 2014. And SUV sales will also be 50,000 in 2015 for a total of 100,000.

    Net profit per car $10,000 . times 100,000 equals $1 billion in 2015. Give that a 30 p/e and valuation equals $30 billion.

    These are forecast, $ 30 billion mkt cap equates to $ 250 per share.

    If they advance the battery pack and range is extended to 350 miles, the stock will be way higher.

    These are my guess estimates, do your own.

  • Report this Comment On October 09, 2013, at 3:09 PM, ffbj wrote:

    Tesla has a removable battery pack. It sort of annoys me when people make pronouncements on things they clearly know nothing, or very little about.

    Currently the battery pack can be changed out in less time than it takes to fill up a standard tank at the gas station. Yes there are always things to consider

    and possibly re-engineer, fire safety in regards to the battery pack, but simply condemning the car wholesale due to a single incident, and not even knowing the basic about the battery pack, is just poor research. The comparison to the Titanic is just silly. I mean that ship was called "Unsinkable," while Tesla only claimed they had the safest car on the road, a statement which NHSA bore out giving it, the Tesla model S the the best rating of any car ever tested.

  • Report this Comment On October 09, 2013, at 3:51 PM, Decoy0527 wrote:

    One of the comments above states that Tesla has a 3 to 5 year competitive lead. No way is that true. BMW, Audi, Toyota are world class companies with tremendous financial capacity and research capabilities compared to Tesla. Tesla has a niche business due to its charismatic founder, and adoring press, and a small but wealthy clientele. Not enough there to warrant its current valuation. My guess is that shares will settle in below $50 in the next two years. Less if there are a few more fires, or if warranty costs go up from present levels.

  • Report this Comment On October 09, 2013, at 4:01 PM, SteveTG3 wrote:

    Decoy I stated that competitive advantage. From prototype at an auto show to showroom is 2-3 years. We've yet to see a prototype from any other company that competes with what Tesla has. In fact we've seen Infiniti and Audi pull their planned offerings off the table indefinitely because they knew they'd fall flat as the I3 from BMW has next to Tesla.

  • Report this Comment On October 09, 2013, at 4:19 PM, RRobertsmith wrote:

    I was short Tesla till i saw there factory floor, now I trade more carefully.

  • Report this Comment On October 09, 2013, at 6:05 PM, threephaseac wrote:

    If any other major OEM made 1 model as good or better than a Model S, they would effectively start to cannibalize the rest of their business.

    The recommendation would be to start a completely new brand, with the major a parent company so as not to dilute or take away the legacy of the existing brand. (Think Acura, Infiniti, Lexus, etc)

    Even still, this will take several years for any other OEM to pull off and Tesla will be rolling out the Gen-III high volume vehicle well before.

  • Report this Comment On October 10, 2013, at 12:14 AM, TurbulentTime wrote:

    Decoy, have you seen fire from gasoline-powered cars? It happens a lot every year.

    Go to Grand Prix, see how the fire spread after each accident during the races. Consumer Reports states legally and confidently that the Model S has the highest safety rating of any crash test. That is unless you are very ignorant and disrespect the officials at Consumer Reports.

  • Report this Comment On October 10, 2013, at 11:45 AM, djplong wrote:

    Aqsimian - I don't mean to be rude but you're making ignorant comments. The natteries are NOT "unremovable". Take a look at the demonstrations that Tesla has made for automated battery swaps that happen in NINETY TWO SECONDS (that's faster than you can fill a gas tank). Based on current statistics, Tesla has had a battery fire per 100 million miles driven at ONE FIFTH the rate of gas powered cars - and that one battery fire from hitting a huge piece of metal debris falling from a truck resulted in NO injuries and the fire NEVER made it to the passenger compartment. You can't say the same for ICE (Internal Combustion Engine) fires.

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