Electric vehicle (EV) stocks like Tesla (TSLA 2.90%), Lucid Group, and Rivian Automotive are among the most talked-about and highest-valued stocks. So, does it add up to suggest EV stocks are overhyped and should be avoided? Let's take a closer look.

Person driving a car from the perspective of the passenger.

Image source: Getty Images.

EV stocks

First, even if EV stocks may be overvalued, it doesn't mean a lot of the hype around the EV industry isn't true. On the contrary, there are strong reasons the industry is in favor. The EV industry is benefitting from several secular tailwinds:

  • The clean energy transition is real.
  • Government support and regulation actively encourage the shift from internal combustion engines (ICE) to hybrid and electric vehicles.
  • Positive investor sentiment creates favorable operating conditions (ease of issuing capital, obtaining top talent, etc.) for companies like Tesla. In turn, it's improving the fundamentals of stocks in the industry.

It all points to EVs being a significant part of the global economy in the coming decades. However, the truth is a lot of this optimism is already reflected in the valuations of EV stocks. Putting the charging network companies aside (they are also very highly valued), you can see the discrepancy in valuation between EV companies (Tesla, Rivian, and Lucid) and traditional automakers Ford (F -0.72%) and General Motors in the chart below.

For reference, enterprise value (market cap plus net debt) to earnings before interest, taxation, depreciation, and amortization (EBITDA) is a standard valuation metric that includes debt loads. Forward valuations refer to Wall Street analyst consensus for the following year.

The valuation metrics for Rivian and Lucid are negative because they are not expected to generate earnings over the next year. Tesla is already profitable, but its valuation looks high, at least on a superficial level.

TSLA EV to EBITDA (Forward) Chart

Data by YCharts.

What about growth prospects?

"High" valuations are not a problem in themselves, not least because companies can grow into their valuations. That's what the market is pricing into Tesla, Rivian, and Lucid right now. For example, the current Wall Street analyst consensus assumes Tesla will grow sales by 56% and 29% over the next couple of years.

Based on this growth trajectory, some assumptions for profit margins, and long-term expectations for market share and EV industry sales growth, it's entirely possible to conclude that Tesla is a good value stock.

Investors aren't buying Tesla for what the company is right now but rather what it will become as it continues its torrid growth in the future. In this sense, EV stocks are not overhyped and reflect investors' confidence in the industry and the leading EV players.

Value is relative

Whenever any investment is appraised or deemed a "good value," it makes sense to ask, "compared to what?" It's a good question because if you assume the EV business is worth "X" based on long-term industry growth projections, you have to assume the EV businesses of traditional automakers to be worth "Y" using many of the same assumptions. You should conclude that the former is a better value than the latter.

That's far from a straightforward assumption because the reality is automakers like Ford and General Motors are aggressively investing in EVs. For example, Ford will only offer EVs in Europe by 2030, and the company continues to invest in expanding its EV capability as it seeks to finesse potential declines in ICE sales. Ford plans for fully EV vehicles to make up 40% of its product mix by 2030.

Electric cars being charged.

Image source: Getty Images.

It makes sense to assume Ford will be a 40% EV company by 2030. Suppose that means valuing the company with anything close to Tesla's valuation for its EV business right now. In that case, the stock could represent an excellent value.

Are electric vehicles overhyped?

The short answer is "no" because the transition to EV is real and will create a long pathway of growth ahead. However, that doesn't mean they are necessarily the best value in the sector. Moreover, given the underperformance in the industry this year -- caused by production estimate cuts -- it's probably a good idea to start looking at some beaten-down stocks in the industry that still have excellent growth prospects in the coming era of EVs.