Electric vehicle stocks like Tesla (TSLA -3.55%) have attracted a tremendous amount of attention in recent years, and it's driven investors to think seriously about adding stocks in the sector to their portfolios. With that in mind, here's a look at why electric vehicle stocks are on every investors' lips at the moment.
The clean energy transition is real
There's no getting away from it; the world is moving away from traditional fossil fuel technologies and toward green technologies. The transition is real, and it's changing the way many industries operate. For example, an industrial giant like General Electric has seen revenue growth at its once-thriving gas turbine business reduced to a low single-digit rate due to the shift in investment toward renewable energy. Investors are now looking toward its renewable energy business for future growth.
Image source: Getty Images.
It's a similar process in the automotive industry, where the transition from internal combustion engines (ICE) to hybrid and electric vehicles (EV) gathers pace. One way to gauge the level of commitment to the shift is by looking at the capital spending plans of the automotive manufacturers. For example, Cognex (CGNX -1.33%) sells its machine vision technology to automotive companies.
Its automotive revenue ramps up when automotive companies spend on expanding production lines. During a Cognex earnings call last year, CEO Rob Willett noted that "we've seen the automotive business globally accelerate faster than we expected in recent months and particularly around electric vehicles," and "the investment is more around electric vehicles, and we're also seeing some larger capital projects coming in."
The pandemic encouraged many automotive companies to forego investment in ICE production (due to a weak sales environment) and accelerate investment in EV technology. Indeed, traditional players like Ford (F 0.17%) are pushing ahead with their investment plans for EVs. Volvo plans to be a fully electric car company by 2030, Ford will only offer electric cars in Europe by 2030, and Volkswagen intends to increase the share of its all-electric vehicles to over 70% by 2030.
The future of the automotive industry is clear, and it's electric vehicles.
Image source: Getty Images.
Government support and regulation
The shift to EVs isn't just coming from the private sector; it's actively being promoted and invested in by governments worldwide. For example, the current U.S. administration has set a target for 50% of vehicles sold to be EVs by 2030.
To achieve that ambitious target, the U.S. will need to invest in charging networks, and the current administration is planning to facilitate multi-billion-dollar investments in charging networks. In addition, the administration is supporting $7 billion worth of funding "to accelerate innovations and facilities across the battery supply chain from battery materials refining, processing, and manufacturing to battery manufacturing, including components, to battery recycling and reuse," according to the White House.
Governments are aggressively investing in an EV future, which is seen as supporting an environment where EV companies can thrive.
Investors are piling into the sector
This is a subtle argument but bear with me. One of the reasons EVs are so high profile is that the industry's fundamentals are improving because investors are piling into the sector. This argument is based on Soros' theory of reflexivity and works a bit like this. Investors are buying into the EV story in a big way. You can see this in the relative valuations between EV company Tesla and traditional automakers such as Ford and General Motors.
A standard valuation method is an enterprise value (market cap plus net debt) over earnings before interest, taxation, depreciation, and amortization (EBITDA). As you can see below, investors are willing to pay very high valuations for an EV-related stock like Tesla.
Data source: YCharts.
The high valuation takes the pressure off of the company operationally. It also makes it easier to raise capital to fund investments. Similarly, Tesla can attract and retain top talent because stock options have proved lucrative. The result is a positive feedback loop whereby Tesla's products improve, and so do its fundamentals, and then so does the perception of the stock. And so, the loop begins again.
Similarly, the investor excitement over EVs encourages investment in the industry and increases the adoption of EV technology. Of course, the increasing adoption of EV technology (electric cars, charging, etc.) means improving fundamentals for EV companies -- the positive-feedback loop.
An EV future
A combination of the clean energy transition, government support, and positive investor sentiment improving the fundamentals is coming together to make the sector attractive to investors. While Tesla and others look overvalued relative to its current business, there are still plenty of other ways to invest in the EV sector.
