Amid Tesla (NASDAQ:TSLA) shares' rally to record highs, analysts and investors continue pontificating on where they'll go from here. Optimism around the forthcoming Model 3 launch is invigorating bulls, while the incredibly lofty valuation levels are feeding the bears.

Dougherty analysts Charles Anderson and Jessica McHugh are now dropping the firm's price target on Tesla from $500 to $375, according to Barron's. That's a pretty big cut, but the underlying reason may not be what you think.

Model X driving on a mountain road

Image source: Tesla.

Changing methodology

The prior $500 price target was set by analyst Andrea James, who left Dougherty in May of last year to start an executive coaching practice. A few months later in September 2016, Tesla head of investor relations Jeff Evanson recruited her as an investor relations associate/consultant; Evanson and James had both worked together at Dougherty before Tesla hired Evanson in 2011 to lead its IR function.

Anderson inherited Tesla's coverage from James, including both her rating and price target, which he reiterated last year. However, the methodology that James used to derive her price target was a bit odd: Her model estimated 2025 earnings and then discounted those profits back to arrive at a $500 price target. On one hand, a long-term focus makes sense for a company like Tesla, since so much of the valuation is predicated on future performance, but price targets are often 12-month targets. Anderson is changing the methodology to "gain consistency with the 12-month Price Target view of the rest of our coverage universe."

The new $375 price target is derived from 30 times estimated 2020 earnings of $12.49. To get there, the analyst is modeling for a 35% compound annual growth rate from 2017 through 2020, which Anderson believes justifies that earnings multiple. Dougherty is still bullish overall, and believes that Tesla still enjoys a "substantial lead in battery technology" and much greater brand strength, citing the 350,000-plus Model 3 reservations that the company has gathered with no advertising.

Using 2020 estimates is more reasonable, as longer-term estimates are generally less reliable since so much can happen between now and 2025, especially for a company like Tesla. There's also more visibility into Tesla's ambitions, as the company said a year ago that it hopes to produce 500,000 vehicles in 2018 and ramp to 1 million vehicles by 2020. Whether or not Tesla can actually pull off those ambitious goals is another topic altogether.

While the prior $500 price target was the Street high by far, the new $375 price target is still the Street high, just not by as wide a margin. That target still represents over 20% upside from current levels. Even Morgan Stanley analyst Adam Jones, one of the most prominent Street bulls, only has a price target of $305, which is roughly where shares are currently trading.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.