Electric vehicle (EV) stocks haven't been immune to the market sell-off. Most companies have fared worse than the broader market. This weakness begs the question: "Are EV stocks safe to buy now?"
While I can't predict the future, I think the market is giving investors solid entry points into one company. Tesla (TSLA -3.55%) is down more than 40% from its all-time high and is beginning to look attractive. So, with regulatory trends blowing in its favor, is Tesla stock a buy?
Image source: Tesla.
Higher valuation while producing fewer vehicles
Tesla leads the world in EV sales by a wide margin, and all four production models ranked in the top 10 of Consumer Reports' most satisfying cars survey in 2021 (assessing all vehicles, not just EVs), with Tesla taking three of the top four spots.
Tesla makes a great product, but what about the stock? For many investors, it's just valued too highly. As of June 9, Tesla's market capitalization was $745 billion. For comparison, the second-largest automaker by market cap, Toyota (TM -0.91%), has a market cap of $229 billion, and Ford Motor Company's (F 0.17%) is just over $50 billion. Yet Tesla's production numbers are far fewer than its competitors.
| Manufacturer | Total Vehicles Sold Q1 2022 |
|---|---|
| Toyota | 2,594,000 |
| Ford | 966,000 |
| Tesla | 310,048 |
Data source: Toyota, Ford, and Tesla. Q1 ending March 31, 2022.
So Tesla's value is much greater than its competitors despite producing fewer vehicles. Logically, this doesn't make a lot of sense. However, Tesla has a few key differences that separate it from the competition.
Superior margins
Tesla is well known for selling directly to consumers, while Ford and Toyota (and other legacy automakers) utilize the dealer model. Ford's CEO Jim Farley recently estimated Tesla saves about $2,000 per vehicle by not using dealers. This business plan gives Tesla better margins, keeping more of the revenue from every vehicle it sells.
As seen in the chart, Tesla's operating margin has steadily improved and is approaching luxury vehicle levels. With a more profitable business plan, Tesla can capture more of its market before other competitors can get spun up, as it can reinvest in its business at higher levels without hurting profitability.
TSLA Operating Margin (Quarterly) data by YCharts
Additionally, once the market opportunity has matured, Tesla can reward shareholders more than other automakers, although I don't see this happening for at least another decade.
Margins are just one reason Tesla is valued higher than other carmakers, but has the stock price come down enough to justify purchasing it?
Using forward earnings projections, Tesla's price-to-earnings (P/E) ratio is 58. In comparison, Ford trades for just under seven times earnings, and Ferrari is at 37. Regardless of how you analyze it, Tesla is still an expensive stock.
However, with gas prices going through the roof and government regulation aiding EV sales, Tesla may deserve the premium.
The competition heats up
The clock is ticking for Tesla, as competitors are ramping up their EV production significantly. Ford is targeting the production of 2 million EVs annually by 2026, and Toyota's goal is 3.5 million per year by 2030. By year's end, Tesla will have the global factory capacity to produce around 2 million vehicles annually, with more factories in the pipeline.
However, if legacy automakers can't pivot away from dealer networks, Tesla will always have a higher valuation due to its margin profile. Ford's CEO favors this switch to a direct-to-consumer model, but government franchise laws prevent this from occurring. Franchise laws were enacted to prevent automakers from opening dealerships to directly compete against private dealers. Because Tesla had no dealers to begin with, it uses a loophole in the system to circumvent these regulations.
Multiple state governments are proposing laws to change these regulations, but it may be years before it is settled. If the government sides with the automakers and abolishes these laws, Tesla's competitive advantage will be erased. On the flip side, if the laws don't get repealed, Tesla will sustain its advantages, as it owns all of its dealerships.
There are a lot of "ifs" with Tesla's stock. However, as a business, it's firing on all cylinders. With automotive revenue rising 87% year over year in Q1 and profits rapidly rising, Tesla's stock is a solid buy. There will be bumps along the way, but the long-term trend favors EVs. Picking up the industry leader is a great way to invest in this space.
