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Is Tesla Motors Inc.'s Stock a Good Buy or a Dangerous Bet?

Tesla Model S. Source: Tesla Motors

A few weeks ago, I set out to really delve into Tesla Motors (NASDAQ: TSLA  )  to decide whether it is worth my investment dollars. 

Let's be clear upfront: Tesla makes some of the coolest cars around, at least in my opinion. CEO Elon Musk has turned the electric-car market upside down with the Model S, the soon to be released Model X, and the upcoming, potentially game-changing Model 3

The Supercharger network and Gigafactory could also be game changers (and you can read more about them in an earlier article). But with all that said, if the valuation doesn't make sense, then what's in it for investors?

What's the potential?
Some investors are likely to find Tesla "un-investable," considering that it is not yet profitable on a generally accepted accounting principals basis, while trading with a market cap of almost $30 billion. 

For perspective, Ford and General Motors trade with a market cap of $66 billion and $55 billion, respectively, while producing millions of vehicles per year. Tesla produced about 22,500 vehicles in 2013. 

If the company's Gigafactory is successful and on time, it will produce enough batteries to supply 500,000 vehicles per year in 2020.

Let's assume that Tesla can produce that many vehicles per year. (Just hang with me for a second, because making estimates on cars that don't exist yet isn't exactly easy.) But here's a quick "estimation table" of what those sales could look like in 2020:

Vehicle Sales (units) Average Selling Price Total (in billions)
Model S 125,000 $80,375 $10.05
Model X 125,000 $86,250 $10.8
Model 3 250,000 $40,250 $10.06
Total 500,000   $30.9

Source: Author's estimations.

The Model 3 has an estimated price of $35,000 -- at least, that's Musk's intention. The Model S starts at $69,900 and the Model X does not have a known price yet, but I used $75,000 as an estimated starting price for the Model X, though this may be conservative. I added a 15% premium to each model's starting price to account for upgrades and higher prices. 

The result is $30.9 billion in sales for 2020, if there aren't any hangups in the Gigafactory and if it does indeed produce enough batteries for 500,000 vehicles per year. Of course, Tesla would need to sell 500,000 vehicles per year as well, not just produce them. 

Anyway, that's one of the better-case scenarios for Tesla. The best case would have the same amount of unit sales, just with higher prices. 

Tesla Roadster. Source: Tesla Motors

What is Tesla -- automaker or technology company?
This has drastic implications with regard to how one should value Tesla's stock. Is Tesla an automaker? Because if so, today's stock price may already be considered fully valued, even based on those tremendous sales estimates for 2020. Allow me to explain. 

The automotive industry trades with an average PS ratio of 0.9. Meaning that if Tesla were to have about $31 billion in sales in 2020, a 0.9 PS ratio would indicate a market cap close to $27.8 billion. 

However, if Tesla is considered a technology company, that sector trades with an average PS ratio of 3. In other words, its hypothetical $31 billion in sales for 2020 could justify a market cap of roughly $90 billion -- over three times today's valuation. 

Truth be told, the answer likely lies somewhere in the middle, that is, between an automaker's valuation and a technology company's valuation. The midpoint, or just about 1.5 times sales, would roughly indicate a market of $60 billion. 

Tesla Model S. Source: Tesla Motors

Foolish final thoughts
The company has to continue improving margins, boosting sales and upping production. Supercharger stations must continue coming on line, and the Gigafactory can't have any major delays.

Aside from significantly boosting the scale of production, the Gigafactory will also significantly reduce input costs, perhaps by as much as 30%. A lot obviously hinges on the Gigafactory, and that's part of what makes Tesla such a gamble and hard to value.

Although the recent announcement of Panasonic joining in on the Gigafactory investment lifts some of the risk off Tesla. 

Tesla makes amazing vehicles, and Musk has tremendous vision. Shares are what I would call "fully valued" at current levels for the next several years. This is because investors have already priced in so much good news and near-perfect execution. Looking into the future by five to 10 years, Tesla appears undervalued.

Of course, this all depends on the investor, too. Those invested in Tesla should be in the stock because they believe in the long-term, disruptive potential of the company, which comes with very high valuation metrics, as well as lots of volatility. So investors should consider these things when determining if the stock is a good fit for them and their tolerance for risk. 

As electric vehicle driving ranges increase, batteries get cheaper, and performance gets better, more and more consumers likely will consider making the move to electric vehicles. For now, Tesla is at the forefront of that movement. 

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Read/Post Comments (6) | Recommend This Article (7)

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 August 17, 2014, at 8:38 PM, drax7 wrote:

    Burning 90 million barrels of oil a day is a more dangerous gamble.

  • Report this Comment On August 17, 2014, at 9:33 PM, Petronilus wrote:

    When you look at all trends of importance, the moment is approaching where EV cars will become the superior option over gas powered cars at mainstream price points.

    Some trends that will tip the scale include:

    Gas prices: going up

    Energy efficiency consumer interest: going up

    Battery energy density: going up (= mileage going up)

    Battery cost per kWH: going down

    Battery manufacturing capacity: going up

    Charging availability: going up

    EV drivetrain simplicity: going up

    EV design competitiveness: going up

    EV car performance: going up

    EV car safety: going up

    Tax incentives for EV cars: going up (globally)

    Coolness of owning an EV car: going up

    Consumer awareness of EV car alternatives: going up

    Number of naysayers: going down (seems like)

    Solar panel cost: going down

    The SUM of such combination of trends is what can turn the market around rapidly. Imagine that suddenly there is a brand new EV car that you can afford and that really just is plain and simple a superior car. People will stop buying gas powered cars when all the arguments are gone for it and my guess is that such moment could be within the next decade.

  • Report this Comment On August 17, 2014, at 11:34 PM, HunterP wrote:

    GM gross profit margin is 5%, Tesla 27%

    GM growth rate is 0, Tesla growth is 70%.

    That is why GM market cap = revenue. Tesla will be different.

  • Report this Comment On August 18, 2014, at 2:06 AM, timlonely wrote:

    Number of dead due to design flaw (and concealed):

    GM = more than a dozens

    Tesla = none

  • Report this Comment On August 18, 2014, at 12:45 PM, TMFDanielSparks wrote:


    I think your ASP for the lower-cost car is far too low. There will almost certainly be an upgrade option for a better battery. And there are a number of other reasons, including the current ASP to entry level price ratio, that 40k is probably far too low. I use an ASP of 55k for the lower-cost car.

    And Tesla has said that the cost cuts at the gigafactory will not be "as much as 30%" but "at least 30%" and Tesla has also said that that statement is "very conservative"

  • Report this Comment On August 18, 2014, at 12:46 PM, TMFDanielSparks wrote:


    Still: I enjoyed your article. Thanks!

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Bret Kenwell

At The Motley Fool I cover consumer goods and industrial companies, and mainly the automakers. I am a long-term investor looking for companies with sustainable and above average growth. I also like to uncover value, dividend-paying companies. Follow me on Twitter @BretKenwell

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