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Why Tesla, Inc. Investors Should Still Be Wary of Valuation Levels

By Reuben Gregg Brewer - Feb 20, 2018 at 9:02PM

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Elon Musk's Tesla is nearly 15% off its recent highs, but that price correction doesn't change much about valuation.

The shares of electric car and solar panel company Tesla, Inc. (TSLA 4.53%) have hit correction territory, falling more than 10% from recent highs in September 2017. But the roughly 13% drop in the stock price has to be put into a broader context before investors make any decisions. That includes a look at valuation, which still could be a problem.

Could be a great company

Before going any further, it's important to point out that this is not an opinion on Tesla as a company. Chief Executive Officer Elon Musk is clearly a visionary with ideas that have pushed the boundaries of the modern world. That includes things like solar panel roof tiles, space exploration, and, yes, electric cars. It could easily be argued that without Tesla's all-electric automobiles forcing their hand, traditional car makers like Ford Motor Company (F 3.89%) and General Motors Company (GM 5.55%) wouldn't have moved as quickly as they have with alternative vehicles.

A hand drawing a scale weighing value and price.

Image source: Getty Images.

As for the cars Tesla makes, well, they are high-tech marvels. Not only do they look cool and drive well, but they incorporate leading edge features. That includes the materials they use, like a heavy reliance on light weight aluminum, and the programming in the cars, like Autopilot, which can largely drive the car itself in certain situations. But none of this speaks to Tesla as an investment.

Little corrected by the correction

To paraphrase Benjamin Graham, the father of financial analysis, price is what you pay and value is what you get. Since the market is more of a voting machine driven by popularity over the short term, investors are often asked to pay more than the true worth of what they are getting. Even after a more than 10% drop in Tesla's shares, it still doesn't look like a bargain. Let's look at a few key valuation ratios.

TSLA Chart

TSLA data by YCharts

The first number many investors look at is price-to-earnings ratio. That's a problem for Tesla because it doesn't have any earnings. In fact, it has yet to turn a full-year profit. Clearly, the company is still building for the future, but at some point Tesla will need to earn money. The big problem with this is that Musk's ambitions for growth have led to huge spending. Without earnings, the company is largely reliant on the capital markets to afford that spending. This is why debt ballooned more than 60% year over year in the third quarter of 2017. With equally large plans for the future, including introducing an all-electric truck and an all-electric tractor trailer, it doesn't look like the denominator in the P/E equation is going to get into the black any time soon.

But P/E isn't the only valuation metric available to investors. There's also price-to-sales ratio (P/S) and price to book value ratio (P/B). The interesting thing here is that these metrics are much lower than they once were, but are still elevated relative to the company's peers.

For example, Tesla's average P/S ratio over the past five years was roughly 8.9 times. However, it's current P/S ratio is around 5.2 times. So the stock looks much cheaper than it once did on this metric. However, this compares to the broader market's price to sales of roughly 2.3 times. Ford and GM, meanwhile, have P/S ratios of 0.28 and 0.38, respectively. Tesla may deserve a premium valuation, but the difference here is extreme.

TSLA PS Ratio (TTM) Chart

TSLA PS Ratio (TTM) data by YCharts

The P/B ratio isn't much better. Tesla's five-year average P/B ratio is 29, with a current reading of around 12.2. Tesla is much cheaper today than it has been. However, the market's P/B ratio is just 3.2. But compared to some auto peers, the story looks even worse, with GM's P/B at 1.4 and Ford's P/B ratio an even lower 1.3. Tesla again looks very expensive despite the price correction.

Father may know best

Graham's most famous book is probably the classic The Intelligent Investor. He cautioned that most investors should take a defensive approach. To him that meant avoiding companies that didn't earn money or pay regular dividends. It also meant waiting for a good deal rather than chasing richly valued stocks. Even after a more than 10% price drop, Tesla still wouldn't pass Graham's defensive investment screens. Tesla is an interesting and innovative company, but it doesn't look like a good deal even at today's lower prices.

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Stocks Mentioned

Tesla, Inc. Stock Quote
Tesla, Inc.
TSLA
$737.12 (4.53%) $31.91
Ford Motor Company Stock Quote
Ford Motor Company
F
$12.01 (3.89%) $0.45
General Motors Company Stock Quote
General Motors Company
GM
$34.82 (5.55%) $1.83

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