When was the last time you saw a Tesla (TSLA 12.06%) advertisement? That's right -- never. CEO Elon Musk doesn't believe in it, as highlighted in his 2019 tweet: "Tesla does not advertise or pay for endorsements. Instead, we use that money to make the product great." Imagine if a legacy automaker like Ford or Toyota had technology like full self-driving vehicles; you'd never see the end of it on television.
Tesla funnels this capital usually spent on advertising into research and development (R&D) to improve its vehicles. With Elon Musk being an engineer, this approach shouldn't surprise anyone.
By creating feature-rich vehicles, the company relies on word of mouth to boost sales driven by customer satisfaction. The results have been as good as any business can ask for, as all four models Tesla currently produces ranked in the top 10 of Consumer Reports' most satisfying cars. In addition, no other manufacturer had more than two within the top 10. Tesla's mindset has resonated with consumers, and the business (and stock) have benefited.
A more efficient business model
Even after combining ad and R&D spending, this chart shows Tesla spends more on its vehicles than legacy automakers. However, Tesla's operating margins are also better than its competitors as of the fourth quarter of 2021.
Data by YCharts.
How does a company that spends more per car than its competitors have better margins? It cut out the middleman from the beginning. While the legacy automakers used dealer networks to build their brands when direct-to-consumer wasn't possible, Tesla has built its business model to exclude them because today's technology allows it. Most people don't like haggling or going to an auto dealership in the first place, so Tesla benefits twofold from this practice.
As noted in the chart, Tesla's operating margins have significantly risen throughout 2021. However, inflationary pressures on raw materials may cause this metric to take a hit alongside the other automakers. On the flip side, rising gas prices may drive more consumers to purchase electric vehicles, giving Tesla an edge on the demand side.
Image source: Tesla.
In 2021, Tesla produced 930,422 vehicles in its three manufacturing facilities, which only have a maximum annual capacity of 1.05 million vehicles. With two factories in Berlin and Texas in the equipment testing phase, Tesla should be able to expand its production capacity in 2022 to meet consumer demand, as long as chip and battery material supply chains can keep up.
With Tesla's increasing its margins and vehicle output, the stock can begin growing into its high valuation. Tesla shouldn't be valued against legacy automakers, but valuation is still something investors should consider when purchasing a stock trading for 337 times free cash flow. If buying the stock with a mindset to hold for at least three to five years, Tesla makes an excellent addition to any growth investor's portfolio.
