Valuing stocks is difficult enough at the best of times, but it's a lot harder in Tesla's (TSLA -3.55%) case. On the one hand, there's excitement around the company's long-term growth projects. On the other, there's the near-term debate around Tesla meeting its production aims in 2022 in the face of supply interruptions and COVID-19-related shutdowns in China. Both matter. Both are material. But should investors be overly focused on them? Here's the lowdown.
Tesla's long-term growth prospects
The short answer is that issues shouldn't unduly trouble a long-term investor, but be aware the stock price will be moved around by these matters. There's an investment case for buying Tesla stock that isn't overly focused on these two debates.
Image source: Getty Images.
Starting with long-term growth projects, when a CEO speaks, investors listen. CEO Elon Musk's statements on the last earnings call will be factored into how some investors feel about the stock. For reference, Optimus is Tesla's humanoid robot in development and full self-driving (FSD) software in beta testing programs. According to Musk on the earnings call:
- "Optimus ultimately will be worth more than the car business, worth more than FSD."
- Regarding the technical capability for FSD: "And I think we will achieve that this year."
- On Tesla's robotaxi in development: "We do a product event for robotaxi next year and get into more detail, but we are aiming for volume production in 2024."
- "It would appear that a robotaxi ride will cost less than a bus ticket."
There's a lot to digest in those statements, and anyone pricing in FSD nearing commercial deployment and robotaxis in volume production in 2024 (with the kind of commercial appeal implied in Musk's statement about ride costs) would have reason to be extremely bullish. That's before considering what the Optimus business might be worth.
There are three ways to think about this. The first is to accept that there's significant potential upside in these projects and accept them as part of the potential upside in the stock.
The second argument is slightly nuanced, but bear with me. The fact that the market may well be pricing in some of Tesla's exciting growth programs means they are more likely to happen. If the market is awarding Tesla a high valuation and the company can quickly raise capital cheaply, then it's easier for Tesla to invest in these projects. As such, they are more likely to happen.
Third, more conservative investors could exclude any potential upside in robotaxis, FSD, or Optimus in favor of simply focusing on the potential in the electric vehicle (EV) business.
Image source: Getty Images.
The near term
Turning to the near term, it's indisputable that the market is reacting to the production issues that the automotive industry is facing right now. Unfortunately, ongoing component shortages (notably semiconductors), the war in Ukraine and its effect on automotive supplies (for example, copper wiring harnesses from Ukraine and palladium from Russia), and lockdowns in China have reduced estimates for light vehicle production (LVP) in 2022.
Given the importance of LVP to the auto sector, a slew of auto-related companies have lowered full-year guidance and suffered production setbacks. Tesla is not immune from these challenges.
After just 305,000 units produced in the first quarter, and Musk saying "the most likely vehicle production in Q2 will be similar to Q1, maybe slightly lower," Tesla will be under pressure to ramp production to around 900,000 in the second half to potentially meet the 1.5 million target.
While it's important not to get too caught up in a few weak quarters of production, a failure to meet production targets would have a financial effect, and that will get baked into valuations. That said, Tesla is a growth stock, and the key to its valuation is what lies ahead rather than what it makes in 2022. The supply disruptions will clear at some point, and investors can look forward to a production ramp while demand for cars remains high.
Valuing Tesla
All told, investors should focus on the underlying fundamentals of the business. Trading on 44 times Wall Street analyst estimates for free cash flow in 2024, Tesla certainly isn't a cheap stock unless you believe the company can maintain its dominant market position in EVs and continue to expand profit margin as it ramps production in the coming years. Of course, that's a debate whose resolution will matter to Tesla's valuation, so buying the stock makes sense if you are positive about it, while avoiding it is the right course if you are not.
Whichever is the case, it's probably a mistake to get too excited about Tesla's more speculative growth prospects, at least if you are likely to price them in prematurely. Similarly, it's also a mistake to get too worried if the company doesn't hit its production target for 2022. These are not the issues that will decide Tesla's valuation over the long term, and there's enough in its car business to get excited about.
