With Tesla (TSLA -1.48%) shares now up nearly 800% over the past year, there is a lot baked into the automaker's stock price.
Take it from Tesla CEO Elon Musk.
"Investors are giving us a lot of credit for future profitability," Musk explained in an email to employees this week, "but if, at any point, they conclude that's not going to happen, our stock will immediately get crushed like a souffle under a sledgehammer!"
With a market capitalization of more than $500 billion, the growth stock has become a Wall Street darling, signaling the market's wildly optimistic long-term view for the company. While the stock's big run-up has been great for Tesla shareholders, here's the problem: the bar is higher than ever.
Can Tesla live up to the market's rosy outlook?
Model X steering wheel. Image source: The Motley Fool.
Profitability is key
In Musk's email, the CEO urged employees to double down on efforts to identify cost savings and make progress on profitability.
"At a time like this, when our stock is reaching new heights, it may seem as though spending carefully is not as important," Musk explained. "This is definitely not true!"
Cost savings efforts will not only help the automaker continue improving Tesla's bottom line but will also help Tesla make its vehicles more affordable, Musk explained. "[W]e have to get smarter about money." He said that even small savings count, as a large number of small improvements can add up over time.
One of the main reasons for Tesla's soaring stock price in 2020 has been the company's bottom-line progress. In Tesla's third quarter, for instance, net income was $331 million and free cash flow was $1.4 billion. This compared to $143 million and $371 million in the year-ago quarter, respectively. Further, management said in its third-quarter update letter that it expects its operating margin to improve over time, "ultimately reaching industry-leading levels" -- even as Tesla increases vehicle production drastically.
If Tesla fails to execute accordingly, shares could get crushed.
Model S interior. Image source: The Motley Fool.
Has Tesla stock soared too high?
Even if Tesla executes well during Q4 and into 2021, there's still good reason to be concerned about the stock's prospects. The valuation has become extremely pricey. The stock trades at 21 times sales, up from just 2.4 times sales one year ago. To live up to its valuation, Tesla will need to continue growing its top line rapidly over the next decade while expanding its operating margin to unprecedented levels for an automaker. This, of course, will require huge success in software -- where the company is working on eventually rolling out autonomous driving capabilities. Of course, there's no guarantee Tesla succeeds on this front.
Musk is right: Tesla needs to execute today like never before. Otherwise, the electric-car maker risks losing the market's vote of confidence in the company's ability to eventually morph into an asset that can eventually generate tens of billions of dollars of profits annually.
With a sky-high valuation like this, Tesla may be one slip-up away from shares getting hammered. Profitability, in particular, will be under the microscope as Tesla grows.
