Electric car innovator Tesla Motors (NASDAQ: TSLA ) 's stock has been sliding in recent days, with the decline kicked off by news that its growth, while strong, isn't turning out to be strong enough. Call it supply-chain difficulties, growing pains, or simply the market's impatience, but Tesla is simply facing the same uncertain future as every other company. Its stock, once priced as though Tesla could do no wrong, is simply adjusting to the reality that imperfections happen.
In the long run, every company -- including Tesla -- is valued based on its ability to generate cold, hard cash -- either through its operations or through the potential liquidation of its assets. The key factors that go into turning those cash flows into a market price are the size, the timing, and the likelihood of those cash flows actually happening.
The more cash a company can generate, and the sooner it can generate it, the more the company is worth. In addition, the more certainty behind the potential for those cash flows, the more they're worth today.
Nobody can predict the future
In truth, Tesla hasn't yet shown itself capable of sustainably delivering profits. For a capital-intensive business that's still fairly early in its life cycle, that's a fairly acceptable position. Some of its problems seem to be supply-chain-driven, suggesting that it will need to continue to invest significant additional capital to continue to grow quickly.
From the backward-looking lens of its earnings reports, in its strongest quarter to date, Tesla was able to generate around $102 million in cash from operations. In that same quarter, it spent roughly $76 million in capital to help boost its operating capacity. The $102 million in operating cash is awesome, but if it'll need to keep spending that cash to sustain its expansion, it'll end up generating very little net cash today.
Say it manages to keep $25 million-$30 million per quarter, or around $100 to $120 million in annual free cash flow generating capacity. Even after the recent slide, Tesla's current market capitalization of around $16.4 billion exceeds a generous measure of the company's demonstrated free cash flow-generating abilities by more than a hundredfold.
Sure, you can make the case that at some point, the expansion capital spending can slow down, and that at some point, the company can grow to where it will generate significantly more operating cash. There are many reasons to believe that Tesla will grow and will very likely prosper in the future. But how much will it prosper -- and when will it reach that point?
Nobody really knows. But the market is waking up to the reality that it will take significant continued investment for Tesla to keep growing rapidly. That pushes back the timing of the company's ability to produce prodigious amounts of free cash, and it increases the capital at risk in investments that may not pay out as expected. And that, in turn, reduces the certainty that those cash flows will be generated.
Still priced for a very strong future
Even after its recent drop, Tesla's market capitalization suggests that the market still expects a very strong future for the company. It's just not quite as certain or quick as the market had previously thought.
As a value investor, I see the potential benefits from Tesla's future growth opportunities. I can also build a spreadsheet model that justifies its current price if everything goes well for the company going forward. However, I can't come up with a high enough level of certainty that the rosy future from that spreadsheet model will come true to justify investing my own cash in the company right now.
As Warren Buffett has said about investing, "In this game, the market has to keep pitching, but you don't have to swing. You can stand there with the bat on your shoulder for six months until you get a fat pitch." Tesla's stock, though down from its highs, isn't trading anywhere near low enough to be a "fat pitch." Tesla certainly has a great potential for a strong future in front of it, but it still needs to prove itself capable of generating all that cash the market is expecting of it.