Tesla (TSLA 11.77%) shares seem to be hitting new highs on a weekly basis over the past year. While this is great for shareholders, it creates an ever-evolving dilemma: Are shares worth their swelling price tag?
For a while, my take on Tesla stock was to hold, despite its soaring valuation. Sure, the stock was getting expensive, but the company was executing at an accelerated pace, cash flow was improving, and the future looked bright, I argued. More recently, however, I've shifted my tone to one that is more cautious, urging investors to hold onto some shares but to also consider taking some profits in the case that the company does better than expected.
While my last look at the growth stock was less than a month ago, shares are already up more than 20% since then. Here are my latest thoughts on this Wall Street darling.
Tesla factory. Image source: The Motley Fool.
Reasons to hold
Tesla has certainly been giving shareholders good reasons to hold onto the stock. During the first quarter of 2020, Tesla launched its Model Y SUV about six months ahead of management's initial timeline. Throughout the year, Tesla rapidly expanded production and made progress on the construction of new factories. And more recently, Tesla has been reporting sharp growth in vehicle deliveries and significant cash flow improvement. Third-quarter free cash flow, for instance, was $1.4 billion. Even when excluding sales of regulatory credits, third-quarter free cash flow was about $1 billion. Further, vehicle deliveries in the second half of the year were up 53% year over year.
Equally exciting is Tesla's potential in 2021. Given the company's aggressive buildout of new factories and production lines throughout 2020, it wouldn't be surprising to see 2021 vehicle deliveries increase 50% or more over 2020 levels.
Selling shares of a business doing this well could be a mistake. After all, Tesla's recent execution essentially exceeded most investors' expectations in 2020. Who's to say the company won't do the same thing in 2021?
Image source: Getty Images.
Reasons to sell
But here's the issue. No matter how exciting Tesla's business is, valuation matters -- and the electric-car maker's valuation is simply difficult to justify.
Tesla currently has a market capitalization of more than $800 billion. Yet trailing-12-month free cash flow comes in at just $1.8 billion. Even on a price-to-sales basis, the stock looks expensive. Tesla trades at about 29 times its trailing-12-month sales and 18 times analysts' average forecast for 2021 sales.
Of course, there's still potential for Tesla to live up to this valuation. But it will likely require execution in speculative areas like self-driving technology and the company's nascent energy-storage business. In addition, there needs to be a tipping point in which electric vehicle sales start rivaling gas car sales.
What should investors do?
All of this to say, my recent opinion on Tesla shares stands, despite a 20% uptick in the stock price in 2021. For investors with a high-risk tolerance and who are willing to hold onto shares for five to ten years or more, I'd give shares a hold rating. Buying the stock at this valuation, however, may be too risky. In addition, investors could consider trimming their position in Tesla, particularly if it has become outsized in relation to other portfolio holdings.
For investors who do decide to hold onto some Tesla stock, expect lots of volatility. Following such astronomical gains, a bumpy ride is likely.
