Tesla (TSLA 0.52%) was the darling stock of 2020. At first, It seemed as if the admiration would continue in 2021 as share prices hitting a record $884 on Jan. 8.
But since then, Tesla shares slipped 8% in a day and are currently trading down almost 4%. Has reality finally cracked investor fervor for Tesla?
A company to keep your eye on
I'm not a big Tesla fan -- but I'm far from a permabear. In fact, I've watched Tesla closely for years now, and the company's shown amazing execution ability despite being in the challenging automotive industry. Tesla fell just short of its goal of delivering 500,000 vehicles in 2020. That was impressive, considering COVID-19's disruptive effect on global manufacturing.
If you bought $10,000 of Tesla stock a decade ago, you would be a millionaire now just from that investment, but Tesla bulls want even more. They're betting 2021 will be another good year for the electric vehicle (EV) maker, and that's why the stock is up about 20.5% so far in 2021, in spite of the recent drop.
But I don't think Tesla stock is a buy right now, for two simple reasons.
1. It's closing on a trillion-dollar market cap
The year 2020 was a bumper one for Tesla as a company. It delivered a record 139,000 vehicles in the third quarter of 2020, which helped propel the company to a fifth consecutive quarter of profit. In addition, major automakers like General Motors announced deeper forays into the EV space, lending credence to Tesla's push for battery-powered vehicles. Investors responded by sending Tesla shares into overdrive, and the stock rose almost ninefold.
Tesla's breathtaking rally -- as well as its recent inclusion in the S&P 500 -- has drawn in a new crowd of retail and institutional investors. Meanwhile, existing Tesla bulls are holding on to the stock, reciting the mantra of long-term investing.
Both camps share a common belief -- that Tesla will continue skyrocketing in 2021, riding on rising car production and new model releases.
But it will be almost impossible for Tesla to repeat 2020's cannonball rally. Tesla is already nearing $800 billion in market capitalization, and it might only be a matter of time before it hits the $1 trillion valuation milestone. Merely doubling from current levels will make Tesla one of the world's three biggest companies!
Size matters aside, Tesla's valuation is excessively high at 29 times trailing sales. General Motors is trading at less than 0.5 times sales.
Of course, Tesla's fans believe the company's more than just an automaker -- it's also involved in renewable energy, autonomous vehicles, and more recently, ride-sharing. But while this argument makes perfect sense, all this is already reflected in Tesla's exorbitant share price.
Tesla's investors may think they're hedging bets on a "high risk, high reward" situation. But those expecting another threefold or fivefold return in 2021 will likely be disappointed.
2. As expectations meet reality, Tesla shares may face a sharp correction
So far, most investors have focused on what could go right for Tesla -- not what could go wrong. This means they have looked at Tesla's massive potential as a leading, global EV player, a market-leading autonomous ridesharing provider, and more. For Tesla, all this is possible -- but still a work in progress.
The reality is that Tesla is still mainly a carmaker, for now, and in the near future. As a result, it's subject to all the risks faced by automobile businesses, including production delays, supply chain disruptions, recalls, and regulatory battles. There's a reason why shares of Tesla's peers in the MSCI World Automobiles Index -- household names like Toyota, Volkswagen, and General Motors -- have remained more or less flat over the past five years.
Sooner or later, Tesla will get into some trouble that causes it to miss market expectations. This could result from the ongoing global recession, escalations in the U.S.-China trade war, or even a simple production delay.
When that happens, investors might get cold feet. Then gravity will pull Tesla's stock back to Earth.
Let's see what would happen if Tesla's valuation narrowed from 29 times trailing sales to 10 times trailing sales. That's still over 20 times what General Motors trades at. But to get there, Tesla shares would fall 66% -- turning every $1,000 invested to $440.
Tesla is a great company with a cliff-hanger valuation
Thanks to its ambitious CEO, Elon Musk, Tesla is a one-of-a-kind company. With Musk at the helm, Tesla has positioned itself for leadership in electric cars, renewable energy, and other game-changing industries.
But a great company is not necessarily a great investment. We all know that overpaying for a stock can turn a great company into a bad investment. Tesla -- despite its visionary leader and incredible potential -- is a shaky investment proposition because investors have priced in all of the roses, and none of the risks.
Everybody laughs when their stock goes up. But if Tesla hits a pothole -- and chances are it will -- there will be many tears. Even if you're a diehard Tesla HODL-er, at current stock prices you'd be better off buying an actual vehicle from the carmaker. At least, you will likely enjoy the experience as a Tesla car owner. I can't say the same for Tesla's shareholders.