The entrepreneurial instincts of Elon Musk -- the multibillionaire technological wiz behind Tesla Motors (NASDAQ:TSLA), SolarCity, and SpaceX -- allow Musk to take practical steps to manifest a larger vision, whether it be with cars, energy delivery, or space travel. In 2013, Tesla Motors was tapped as one of the top 10 most innovative businesses in the world by Booz & Company. While few can doubt the innovative capabilities of Musk and Tesla Motors, investors should be cautious about jumping into Tesla at current levels. Innovation can come with a price, and Tesla shares are priced for perfection after increasing 353% in 2013.
Tesla's high expectations
Trading at a price/sales ratio of 10.8 compared to the auto industry average of 0.58, Tesla Motors' stock price reflects high expectations for future performance. Tesla is now valued at $18.5 billion, despite clocking positive net income just once in the past year ($11.12 million in 2013's first quarter). This was the company's first and, so far, only profitable quarter since its founding in 2003.
Tesla's financial performance is improving -- the company's net loss so far in 2013 is $57.75 million, a marked increase from 2012's net loss of $396.21 million. Tesla has managed to produce $128.23 million in operating cash flow so far in 2013, a major improvement compared to negative $266.08 million in 2012.
Tesla's prospects are better understood after reviewing the company's innovative style. Tesla practices "top-down" innovation, beginning with the production of a high-priced, low volume car (the Roadster) in 2008, then moving toward a medium-priced, medium-volume car (the Model S) in 2013, with a low-priced, high-volume car slated to be released by 2017 (the Model E). Tesla's latest car, the Model S, sells for $69,900 and up -- and it is projected that Tesla delivered 21,500 Model S vehicles in 2013.
Tesla's rich valuation builds in three major expectations for the company moving forward, as I see it:
1) The Model E will sell like hotcakes (despite costing more than $30,000).
2) Tesla will profitably produce its vehicles.
3) Tesla will outdo a growing number of competing electric and hybrid vehicles.
If Tesla does indeed meet or exceed expectations with these three points, the company will likely prove to be a winning investment going forward. But at this point, that is a major and speculative if, and it plays a major role in determining whether Tesla shares are reasonably valued.
Car of the future?
The overarching question is whether Tesla can become a profitable competitor in the global automotive market. Tesla is taking key steps to make electric vehicles a common reality, but the performance of the company (and stock) is hinging largely on the Model E's release in a few years. Just how great are these cars?
Tesla's all-electric vehicles, which can travel over 200 miles on a single charge, essentially represent the first realistic alternative to gasoline vehicles (and hybrids) that could potentially be offered at a competitive price. Tesla is in the midst of building a "Supercharger" network of battery charging stations, helping solve the age-old problem of charging electric vehicles on the go. Presently Tesla has 49 charging stations in North America and 14 in Europe.
Consumer Reports calls Tesla's Model S "the highest-rated car we've tested in the last five years." Tesla's technological design packs a powerful punch that will be difficult for competitors to match, gasoline cars or otherwise. Tesla's innovative manpower increased after the company recently brought on board two Apple design and manufacturing veterans, Doug Fields and Rich Heley. It will be challenging for traditional automakers to compete against Tesla's silicon valley approach to car design and assembly.
Foolish final thoughts
While Tesla is proving itself as a promising automotive innovator, the success of Tesla's stock hinges upon near-flawless execution over the next several years. We still have at least two years before the Model E is officially released. In the meantime, the company is struggling to net a profit or produce sufficient cash flow to finance capital expenditures; so far in 2013 Tesla has produced negative $46.56 million in free cash flow. I am reluctant to jump in as a Tesla investor because the company still has things to prove to maintain such a premium valuation.
If Tesla executes very well, the company could join the ranks of Toyota within the next two decades -- in which case the stock would be a 10-bagger from current levels. Should this be how things pan out, the present valuation of Tesla doesn't much matter in the grand scheme of things.
I would jump at the opportunity to invest in Tesla should the stock take a sizable hit. Still, at least until the Model E's mass release, Tesla shares are overly speculative at current levels for my taste. Long-term investors with a strong stomach for volatility may be comfortable opening a position in Tesla at today's levels, but should first recognize that the stock's valuation is hinging upon excellent execution at the company in the next several years. For now, investors may be able to find more suitable places for their investing dollars.
Fool contributor David Kretzmann has no position in any stocks mentioned. You can follow David on his Foolish discussion board, Pencils Palace, on CAPS, or on Twitter @David_Kretzmann. The Motley Fool recommends Tesla Motors. The Motley Fool owns shares of Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.