Tesla (NASDAQ:TSLA) has been one of the market's best performers since its IPO, but it's one stock I've never been able to get myself to buy. And now that shares are trading over $1,500, it may not ever make it into my portfolio.
As we stand today, I think the market is looking at Tesla incorrectly, and that's why I see it as being extremely overvalued. It's being priced as if it's a technology stock, but it doesn't have any characteristics of typical tech stocks. And I don't see that changing.
What makes tech stocks great
Technology stocks have been enormous winners for investors who have picked the right companies over the last few decades, and there's a big reason for that. If a company is built correctly, it can spend money on research and product development to build a technology, and then sell it over and over and over for a very low marginal cost for each incremental customer.
Microsoft (NASDAQ: MSFT) uses this to its advantage with Windows and Microsoft Office, which it spent hundreds of millions of dollars to develop but then was able to sell millions of times over to nearly every PC user in the world. Alphabet (NASDAQ: GOOG)(NASDAQ: GOOGL) is doing something similar on the Internet, developing valuable technology and a search engine and then allowing users and advertisers to use the platform billions of times per year, capturing small amounts of revenue each time. The common thread here is that the marginal cost of the next incremental user is very small, and therefore the profit margin of each incremental user is very high.
Tesla's business doesn't act like this at all. It looks and acts a lot more like a manufacturing company because that's what it is. The next customer buying a Model 3 vehicle, for example, may generate a gross margin of around 25% for Tesla if the company is operating efficiently. But it isn't approaching typical incremental tech margins of 70%, 80%, or more.
There also isn't significant recurring revenue in Tesla vehicles, which is very common for technology companies. Once you become a Microsoft user, for example, it's likely that your next device will be another Microsoft product. And given the life span of technology products, that can be recurring revenue every two to three years. At a company like Google, once you become a user, Google can generate value from you nearly every day.
Tesla gets all of its revenue up front, and if its vehicles are high quality, they'll last users (original owners or used-car buyers) for decades.
Priced like a technology stock
Despite the fact that Tesla isn't really a technology stock, it's priced like one. It trades for a higher price-to-sales ratio than Alphabet and Facebook and near that of Microsoft.
The implication is that Tesla is expected to grow rapidly and generate high profits. But it hasn't shown the ability to generate consistent profits, and in a capital intensive business that's very competitive, I question if the extraordinary profits will ever come.
The technology play in transportation
Just because I don't see Tesla as a technology company in transportation, does it mean there aren't transportation companies that won't look a lot like tech stocks? Uber (NYSE:UBER) and Lyft (NASDAQ:LYFT) are examples of companies where a technology platform can be used over and over with very little marginal cost for serving the next incremental customer. The problem with their platforms is that they don't own the vehicles and have to pay drivers in the relatively low-margin ridesharing space.
If we think about what the future of transportation looks like, Uber and Lyft are good models of using technology in transportation. But they've even struggled with high costs because they have to pay thousands of drivers across the country.
Tech's disruption of transportation will really come when autonomous ride-hailing platforms are introduced. This is what General Motors (NYSE:GM) is building with the Cruise Origin, and we know Uber and Lyft are eyeing driverless solutions as well.
Tesla is building autonomous driving technology, but it's far from an industry leader in the space since its vehicles do not adapt well to fully autonomous ridesharing solutions.
I don't think the value in transportation companies becoming technology companies will come in increasing their manufacturing capacity the way Tesla has over the last few years. It will be found in leveraging a platform of technology and ridesharing vehicles to attract the largest user base to serve with rides over and over again.
Tesla is built to disrupt the old world of auto manufacturing
I have to admit that Tesla has built an extremely valuable business if we compare it with the old model of doing business in auto manufacturing. Eliminating the dealer model, building a fully electric platform, and adding in the supercharger network has created a lead that legacy companies may not be able to catch up to.
But as I look at the value of Tesla stock and think about what transportation will look like when my three-year-old son reaches driving age, I wonder if he will be driving at all. I find it more likely that in an urban area, he'll simply request a ride from any number of ridesharing platforms on an app, and within minutes the driver of this vehicle -- if there even are drivers by then -- will show up at his front door.
At the end of the day, transportation as a service is more of a typical technology business than manufacturing cars is. And if the market is going to keep giving Tesla a technology-level valuation, I guess I'll stay out of the stock.