Like it or not, the regulatory push toward electric vehicles (EVs) is undeniable. Because of this trend, several new companies have risen to meet demand before legacy automakers can pivot their business models. These companies have also brought both business and technological innovation, as these upstarts are doing away with the dealership model that compresses legacy automakers' margins.
My top EV stock is likely no surprise; it's Tesla (TSLA 4.96%). Tesla is the worldwide leader in EVs, and many investors have made great returns by purchasing the stock of the industry leader in expanding markets. Even though the stock has a lot of hype built into it, I believe it still has room to run.
Image source: Tesla.
A differentiated business model
As I mentioned above, Tesla doesn't use the dealer network. This practice was necessary throughout the last century when ordering directly from a car manufacturer wasn't feasible. Once many mom-and-pop dealerships sprang up, the government came to their rescue by enacting franchising laws when automakers tried to open their own dealerships.
Tesla sidesteps these laws by having customers purchase the vehicle online or at one of its few galleries. Then, the vehicle is technically purchased through an international importer and delivered to customers. Ford's CEO estimates that Tesla saves around $2,000 per vehicle by selling directly. He also expressed interest in switching to this practice, but government regulations prevent Ford from doing it.
For the time being, Tesla has a unique competitive advantage shared by other EV makers like Rivian. This business model allows Tesla to have superior margins compared to legacy automakers.
TSLA Operating Margin (Quarterly) data by YCharts.
Because Tesla generates significantly higher operating margins than its competition, Tesla can afford to reinvest in its business at a rate no one else can. This is why I believe Tesla deserves a higher earnings multiple. However, trading for 59 times forward earnings at recent prices, Tesla is by no means cheap. Typical legacy automakers trade around 5 times earnings, albeit with much lower margins.
It's hard to pinpoint what a fair multiple for Tesla is, as it is a unique company with a unique product. I think a solid comparison is semiconductor company Advanced Micro Devices (AMD 1.33%). Why? It is a company with similar operating margins, a technologically advanced product, and operates in a historically cyclical industry. AMD trades for around 20 times forward earnings, which is still much cheaper than Tesla.
Is this comparison perfect? Absolutely not. But I think it gives investors a good idea of what to expect when Tesla reaches maturity.
But Tesla isn't anywhere close to mature yet.
Business expansion
In its first-quarter 2022 conference call, CEO and co-founder Elon Musk stated that Tesla has a long-term goal of producing 20 million units per year. For reference, Tesla produced 1.06 million units in the trailing 12 months. This goal is ambitious, as Ford and General Motors produced just over 10 million wholesale units combined throughout 2021. Granted, the chip shortage impacts this number. Will Tesla be able to meet this goal? I'm doubtful, as car manufacturers across the globe only produced 80 million cars in 2021. Still, it provides Tesla a "pie in the sky" goal to work toward.
With Tesla only about 5% of its way toward its goal, it is by no means done growing. Management sees vehicle deliveries growing by 50% annually over a "multi-year horizon." While not quite one-to-one, this means investors can expect revenue (and profits if it maintains its margins) growth of around 50% -- that's a huge and bold prediction.
But how long is a "multi-year horizon"? At its current capacity, Tesla can produce about 1.05 million vehicles annually. When its Berlin and Texas factories come online, they should add around 1 million more vehicles to Tesla's capacity. With Tesla producing 1.05 million vehicles in the last 12 months, if it grows by 50% annually it will hit its production cap within two years. While this isn't a long time, Tesla is already starting the process to stand up more factories, as Tesla has already filed documents to expand its operations in Shanghai.
Threats
Although Tesla predicts it can do this, Ford, GM, and others will likely have a competent EV business by then. This competition won't necessarily reduce Tesla's margins, but if consumer demand can't keep up with increased EV capacity, Tesla and its competitors won't have anyone to sell to.
Keeping with this theme, increased production means more strain on raw materials. Specifically, the price of high-capacity battery materials like lithium (up 392% in one year) and cobalt (up 63%) have exploded. If these two materials continue to rise, EV prices will rise and put them out of reach of many consumers.
As for the stock, today's market shows no love for any company, let alone highly valued ones. So Tesla's stock may continue to fall, giving investors even better opportunities to snag some. However, I think investors can begin easing into Tesla's stock anytime.
Tesla has begun switching its battery composition in standard range vehicles, and it also has a significant first-mover advantage compared to the legacy automakers. This first-mover advantage allows Tesla to establish a loyal customer base, that will drive repeat purchases if Tesla can maintain it. Tesla has best-in-class EVs and will likely remain there even as competitors enter the market. The stock may be expensive, but if it can accomplish its long-term goals, it will still be a fantastic investment, even at today's valuation.
