Electric vehicles (EVs) are cheaper to operate, cheaper to maintain, and more eco-friendly. Those benefits look even better when paired with tax credits, a tactic taken by a growing list of governments in an effort to cut carbon emissions. Not surprisingly, the industry is growing quickly, and EV sales are expected to accelerate to 6.4 million units in 2021, up 98% over the prior year.

Few companies have benefited from that trend as much as Tesla (TSLA 1.78%). Over the last three years, the stock has produced an annualized return of 137%, and Tesla briefly crossed the trillion-dollar market cap threshold in October. But recent market volatility has knocked 24% of the share price.

So is now a good time to buy Tesla stock? Let's dive in.

Blue Tesla Semi driving down an empty road surrounded by grass.

Image source: Tesla

Tesla has a strong competitive position

CEO Elon Musk has often said manufacturing efficiency would be one of Tesla's greatest competitive advantages. In the past, legacy automakers were able to laugh off those comments, but the company appears to be making good on that promise. In 2020, Tesla posted an industry-leading operating margin of 6.3%, according to management, and that figure ticked up to 14.6% in the most recent quarter, despite headwinds created by chip shortages.

The driving force behind that advantage is innovative engineering. A few years back, Tesla started producing its 2170 battery cell, a product that Musk called: "The highest energy density cell in the world, and also the cheapest." In fact, Tesla pays just $187 per kilowatt-hour (kWh) to build battery packs, the most expensive part of an EV. That's 10% less than the next closest competitor, and 24% less than the industry average, according to Cairn Energy Research Advisors.

And Tesla's capacity for innovation extends to other areas as well. Last year a partnership with SpaceX led to the creation of a new aluminum alloy that allowed Tesla to cast the front and rear body of the Model Y as a single piece of metal, boosting manufacturing efficiency by eliminating the need to weld those parts together.

More broadly, Tesla's facilities were designed to build electric cars, but legacy automakers built their factories for internal combustion engines, meaning they will need to invest billions to retool existing infrastructure. In fact, Ford plans to invest more than $30 billion through 2025 to fuel its EV business, and General Motors will spend $35 billion over the same time period. That should reinforce Tesla's cost advantage.

Here's the bottom line: Through October 2021, Tesla is the world's leading manufacturer of EVs, holding 14% market share. That puts the company 5.5 percentage points ahead of the next closest brand.

Tesla is growing its business quickly

In recent years, Tesla has dramatically expanded its production capacity, due in part to improvements at the factory in California, as well as the opening of Gigafactory Shanghai. The latter also localized its China businesses, cutting shipping costs associated with moving cars across the ocean.

Collectively, Tesla's strong competitive position and growing production capacity have translated into impressive financial results.

Metric

Q3 2019 (TTM)

Q3 2021 (TTM)

CAGR

Revenue

$24.4 billion

$46.9 billion

39%

Free cash flow

$873.0 million

$2.6 billion

71%

Source: YCharts. TTM = trailing-12-months. CAGR = compound annual growth rate.

Looking ahead, Tesla has new factories set to open in Texas and Berlin in the near term. That should further boost production capacity and localize its European business. Likewise, the Tesla Semi is set to launch next year, and its newest battery cell (the 4680) will be incorporated into vehicles. That technology is particularly noteworthy, since it will boost range by 54%, cut production costs by 56%, and reduce capital expenditures by 69% -- in other words, the 4680 battery cell will reinforce Tesla's cost advantage.

Over the long term, Tesla believes it can increase output at an annualized pace of 50% over a multi-year horizon. To put that in perspective, Grand View Research estimates that EV unit sales will grow at 41.5% per year through 2027. In other words, Tesla believes it will grow faster than the industry, gaining market share.

Tesla is more than an automaker

In addition to his conviction regarding manufacturing efficiency, Musk also believes that people will eventually think of Tesla as an artificial intelligence and robotics company, not just an automaker. And there's plenty of evidence to support that theory, as Tesla has positioned itself as a frontrunner in the race to build an autonomous vehicle.

In 2020, a teardown of the Model 3 revealed that its full self-driving hardware (i.e. the in-car supercomputer) was six years ahead of the competition, according to Nikkei Asia. And in 2021, Tesla introduced the D1 chip, a custom semiconductor that will theoretically make the company's Dojo supercomputer the fastest AI training machine in the world.

To that end, in September 2020, Musk made the following comment: "About three years from now, we're confident we can make a very compelling $25,000 electric vehicle that's also fully autonomous." If successful, Tesla could then launch its autonomous ride-hailing network, pioneering an industry that Ark Invest values at $1.2 trillion by 2030.

That being said, other analysts see even greater opportunities down the road. Adam Jonas of Morgan Stanley believes Tesla could launch a flying car business -- that's right, a flying car business -- by 2050, pioneering an industry that could reach $9 trillion.

Tesla trades at a pricey valuation

Tesla currently has a market cap of $937 billion, meaning it's worth more than the next eight automakers combined. And the stock trades for a very pricey 23 times sales, putting it on par with many software companies.

However, that actually makes some sense. A large part of Tesla's future hinges on its full self-driving software, which will not only power its own self-driving cars, but could also be licensed to other automakers. Of course, Tesla is still a very expensive stock at its current price, even after falling 24%. But given its strong competitive position and massive market opportunity, I think it's OK for risk-tolerant investors to buy a few shares right now.