These are heady times for Tesla (TSLA 1.56%) investors. After all, the stock is up nearly 600% on the year. Enthusiasm over its leading electric vehicles has catapulted Tesla to become one of the most valuable companies in the entire stock market. Reports that Tesla will be added to the S&P 500 index in December are responsible for the stock's recent surge, but this is just the latest in a string of great news.
Yet, with Tesla's market cap sitting at over $560 billion, Elon Musk himself may be growing nervous about its sky-high stock price. He voiced his concerns to employees in a recently leaked internal email.
"Our stock will immediately get crushed"
In the email, Musk asked employees to redouble their cost-savings efforts to bolster Tesla's profitability. Right now, the market is giving Tesla a huge benefit of the doubt that it will not only grow a lot, but also achieve margins more akin to the software industry's than the auto industry.
Next year, analysts predict Tesla will increase revenue by just under 50%, but expect earnings per share to grow an even greater 72%. That means a streak of growth and margin expansion is embedded in the stock price.
Now that the company achieved profitability in the recent year, Musk seems keenly aware that showing investors increasing profits will be key to prevent disappointment that could lead to a huge sell-off in Tesla's high-flying stock. Per his internal email to employees:
When looking at our actual profitability, it is very low at around 1% for the past year. Investors are giving us a lot of credit for future profits, 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!
For holders of Tesla stock, this is not great to hear. However, Musk has also said in the past that Tesla's stock price is too high, and that hasn't prevented it from surging even higher.
Why Musk is so focused on costs right now
Musk is certainly right to focus on continued cost-cutting -- and not just for the sake of the current year's profits. Musk likely knows that in order to sell the volumes of vehicles he wants and the market expects, Tesla will likely have to keep lowering the price of the Model 3. Currently, Model 3s go for about $38,000. That's before other add-ons that can easily push Model 3s up to $50,000 or higher.
That's still too expensive for a mass-market vehicle, even with gas savings. Tesla recently outlined a goal of eventually selling its lowest-cost models for $25,000 in the next three years. The new vehicle would be enabled by improved battery cell technology that lowers the cost of the EV battery, but it's still really, really hard to do.
According to this recent internal email, though, Musk is apparently doubling down on the frugal cost ethos even beyond new battery designs:
Much more important, in order to make our cars affordable, we have to get smarter about how we spend money. This is a tough Game of Pennies -- requiring thousands of good ideas to improve part cost, a factory process or simply the design, while increasing quality and capabilities. A great idea would be one that saves $5, but the vast majority are 50 cents here or 20 cents there.
Encouraging, or worrying?
The recent email could be either an encouraging or worrying sign for investors. It could be worrying in that Musk might be realizing that Tesla can't hit Wall Street's lofty margin expectations with its current cost structure and technology.
On the other hand, it could also be encouraging that Musk is rallying the troops around this initiative. Under Musk's leadership, Tesla has pulled itself out of deep holes before. It has achieved goals many thought were impossible.
If the recent call to arms yields big cost breakthroughs, that could be a positive. One would much rather have a CEO take problems head-on than ignore them and let the company fall behind.
But the current stock price is already assuming all kinds of good news already
Just after Tesla was included in the S&P, noted value investor Michael Burry, one of the investors profiled in The Big Short, revealed he was shorting Tesla stock. That could be a worrying signal that Tesla's stock has finally topped out. Many other value-oriented investors have shorted Tesla in the past, all of whom lost lots of money on that bet against the company. However, it's hard to argue with Burry's contention that Tesla's stock is incredibly expensive right now, as the market is pricing in all sorts of good news for EVs well out into the future.
In order to stay invested in Tesla at these levels despite Musk's concerns and Burry's short, you really, really have to believe Tesla will go on to dominate the auto industry, while also moving into other energy products with large markets and high margins as well. For me, it's fun watching from the sidelines, but Tesla remains far too rich for my blood.