Outspoken CEO Elon Musk is an active Twitter user, regularly using the platform to share information about Tesla's (TSLA 4.96%) business and products and comment on hot news topics. His rambling has unfortunately gotten him into trouble in the past -- even causing him to lose his position as chairman of the electric-car maker's board.
Despite his tweetstorms and rants of the past, Musk still managed to surprise investors last week when he commented on Tesla's stock price. Shares had become overvalued following the growth stock's torrid rise over the last year, he said. More specifically, he wrote, "Tesla stock price is too high imo."
As someone bullish on Tesla's long-term business prospects, you might think I'd disagree with Musk's opinion on the stock. But I think he's right -- though that doesn't mean I've become a bear regarding the company's stock price. I'm still bullish on the stock for the long term; I just don't think shares are a great buy today, following a 200% gain over the past 12 months.
Given Tesla's recent accelerated pace of business execution, however, I do think current shareholders of the electric-car maker may want to consider holding for the long haul, despite the stock's frothy price.
Model 3. Image source: Tesla.
Priced for perfection
While Tesla's $142 billion market capitalization may seem like nonsense at first (especially considering that the company sold only 368,000 vehicles last year), some context on its uncanny growth quickly shows why investors are paying a steep premium for this stock.
Consider the following:
- Tesla's $26 billion in trailing-12-month revenue is almost four times its 2016 revenue.
- Tesla's trailing-12-month gross profit of $4.7 billion is more than twice its 2017 gross profit.
- Vehicle deliveries grew 50% year over year in 2019 -- and that was on top of 138% year-over-year growth in 2018.
Data source: Tesla quarterly updates. Chart by author. *Model Y deliveries didn't start until March 2020.
Despite this wild growth, Tesla has barely scraped the surface of the global auto market. About 90 million vehicles were sold in 2019. It's easy to see why some investors think the sky's the limit for Tesla's future, particularly if consumers hit a tipping point in which they begin preferring fully electric vehicles.
Still, Tesla shares are arguably already priced for perfection. Consider that Tesla's trailing-12-month revenue would have to quadruple over the next five years for the automaker's net income to surpass $5 billion -- and that assumes Tesla can sport the same net margin that BMW does. Even if this happens, Tesla would still have to be growing by double digits five years from now in order to justify the automaker's share price today.
Why Tesla stock may be worth holding on to
Despite the seemingly astronomical growth required to justify Tesla's current stock price, the company's growth so far has been astounding, arguably exceeding most of the Street's expectations. This has been particularly true of the company's business execution recently. In late 2019, Tesla started producing Model 3 vehicles at a new factory in Shanghai less than a year after breaking ground in the factory. In March 2020, the automaker launched its new Model Y crossover six months earlier than initially planned. Finally, 2019 free cash flow was about $1 billion, up from negative $222 million in 2018 and negative $4.1 billion in 2017.
For those who believe electric cars are the future, Tesla stock may be worth sticking with. Sure, I'd look for shares to sell off to levels below $700 before buying the stock. But given the company's execution of late, it may be worth holding on to this stock for the long haul if you're already a shareholder. Shares are expensive for a reason: Both Tesla's recent growth and the company's growth prospects are nothing short of extraordinary.
Tesla factory. Image source: The Motley Fool.
Of course, investors should limit the size of a position in any stock whose price is based primarily based on future growth prospects rather than on profit levels already demonstrated. Numerous challenges could hinder Tesla's future growth. For instance, if consumer adoption of fully electric vehicles wanes or if competition takes a toll on Tesla's growth trajectory, shares could fall sharply.
Indeed, Tesla's prospects are being challenged as we speak, with the coronavirus forcing the company to temporarily pause manufacturing in California and close many of its stores around the world. If the automaker can't resume production soon, this could force Tesla to raise more debt and increase its cost of capital.
However, Tesla shareholders may want to give the electric-car company a chance to keep up its astounding growth, particularly after its recent impressive achievements. A good straightforward way to approach Tesla stock is to continue owning it as long as the company is meeting or exceeding expectations. Of course, this will make for a very bumpy road, because shares will undoubtedly become overvalued from time to time, setting the stage for occasional massive corrections. But patient investors will likely be rewarded handsomely if Tesla can keep growing rapidly and continue taking market share from incumbent automakers.
