Goldman's Base Case for Tesla Motors: 42% Downside

"Wall Street rises again as Ukraine woes ease" is the Reuters headline at the top of the Yahoo! Finance homepage as I write this. If you can consider that Russia's first annexation of a European territory -- Crimea, in this case -- since the Second World War represents an easing of Ukraine's woes, then the headline is accurate. At least the statement about Wall Street rising is accurate, as the benchmark S&P 500 gained another 0.7% on Tuesday, with the narrower Dow Jones Industrial Average (^DJI -0.11%) up 0.6%. The S&P 500 is now back to within half of a percentage point of its March 7 record (nominal) high. Tesla Motors (TSLA 12.06%) managed to outperform the broad market (again) with a 2.6% gain, ostensibly off a raised price target from Goldman Sachs. If that is the catalyst for today's price action, the market really ought to take a look at how Goldman derived its new target.

There is reasonable doubt as to whether Goldman's note was the catalyst for Tesla Motors' share price appreciation -- after all, while Goldman analyst Patrick Achambault did raise his price target for the stock from $170 to $200, that's still 15% below yesterday's closing price. However, in a market that is breathless when it comes to certain growth names -- Tesla being very prominent among these -- investors are adept at zeroing in on only those facts that suit their credo, which is that these names are going to the moon.

As such, Goldman's note certainly gives the growth cultists something to work with. Archambault lays out five different scenarios for Tesla Motors' trajectory with different assumptions for market share and profitability in 2025 and concerning the multiples investors might be willing to pay. The most aggressive scenario has the shares worth $498 -- more than double today's closing price. Two of the other five scenarios offer the perspective of gains of 92% and 45%, respectively.

However, once you look at the full set of scenarios -- and the probabilities Goldman is attaching to them -- one starts to get a sense of the skewed payoffs and massive risk associated with this stock:

Source: Goldman Sachs.

Goldman's three "upside" scenarios suggest a nice payoff, but they aren't very likely -- investors have just 1-in-4 odds of hitting one of them. The downside scenarios, on the other hand, aren't pretty: Goldman believes that investors have 3-of-4 odds of a minimum 42% downside from today's closing price. The worst-case scenario -- which has the same odds as the three upside scenarios combined -- suggests the stock could hand investors a two-thirds loss.

Goldman's analysis is a good example of the massive spread in outcomes associated with disruptive, hypergrowth companies. Goldman's $200 price target is anchored on high upside scenarios; if those scenarios fail to materialize -- which the broker believes is more likely than not -- the analysis suggests investors could end up nursing some painful losses.