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Is Tesla Stock a Buy Ahead of Its Stock Split?

By Daniel Sparks – Aug 13, 2020 at 6:33AM

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More investors will soon be able to afford shares of the electric-car maker. Should you get in on the action before that happens?

Tesla (TSLA -1.10%) shares got a nice boost on Wednesday following word that the electric-car maker will split its stock later this month. Shareholders will receive five new shares for every one they own. The combined value of those shares will equal what one of the pre-split shares is worth at the time of the split.

Would investors be better served to buy this growth stock now? After all, following the five-for-one stock split, Tesla shares will be more accessible to many investors. The stock is trading at around $1,550 today -- assuming they stay in that vicinity, the electric-car maker's split-adjusted share price will be about $310.

Tesla's Model S, X, 3, and Y

Image source: Tesla.

To buy or not to buy?

There are really two questions here.

  1. Is Tesla stock a buy because of its upcoming stock split?
  2. Does the stock happen to be attractive right now, regardless of the pending split?

Let's explore answers to both.

The implications of Tesla's stock split

The first question is easy to answer. No. A stock split does nothing to make the company more valuable -- and it should have no impact on an investor's view of the stock's long-term potential.

Sure, there may be a spike in demand for the shares when they become more accessible to a larger base of investors (among them, those not already using brokerage services that allow the purchase of fractional shares). Further, a similar surge in demand may occur because the move gives Tesla a greater chance of being added to the Dow Jones Industrial Average; a number of pundits have noted that its current share price would be a deal-breaker in terms of its inclusion in the price-weighted index. Over the long haul, however, the price of Tesla shares will primarily be driven by the company's underlying business performance -- and a stock split has no impact on a business's real, long-term potential.

A look at valuation

But what about the second question? This requires a more thoughtful analysis.

Is Tesla actually worth its market capitalization -- $288 billion at the time of this writing? This answer will depend on whether it can continue growing the number of cars it delivers annually at a rapid rate over the next decade, and if it can eventually generate substantially higher revenue from its vehicle software. Both of these outcomes are arguably priced into the stock today. With just $800 million in trailing-12-month free cash flow, the stock's price-to-free-cash-flow ratio of 360 bakes in a decade's worth of incredible execution and huge sales growth.

While Tesla may continue to dominate the electric-car market and  grow its vehicle deliveries at rapid rates over the next decade, the stock's current valuation requires too much of a leap of faith for me to personally recommend buying it at this level.

Daniel Sparks has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Tesla. The Motley Fool has a disclosure policy.

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