With Tesla (TSLA 0.66%) shares up nearly 50% so far in 2023, it's clear that many investors are regaining their optimism about the electric vehicle maker. But the question remains whether or not the company can maintain its rally amid fears of margin pressure and increased competition. Let's explore why these near-term challenges could be long-term opportunities.
1. Tesla's margins remain fantastic
One of the things that set Tesla apart from most other automakers is its margins, which tend to be high for the industry. In 2022, the company generated total revenue of $81.5 billion compared to an operating income of $13.7 billion, a margin of 16.8%. For comparison, Tesla's large (majority gasoline-powered) U.S. rivals like Ford and General Motors generally have margins in the single digits.
There are several explanations for Tesla's incredible profitability. For starters, the company's recognizable brand means it doesn't have to spend money on advertising and promotion. Management has also worked to unlock manufacturing efficiencies and vertical integration -- expanding its battery manufacturing capacity and bypassing dealership networks by selling cars directly to customers. All this means better margins and bigger profits for the company.
2. Price war fears are overblown
Some Wall Street analysts fear that Tesla could eventually lose its margin advantage because of a recent spate of price cuts. While the company actually raised U.S. prices (by a measly $250) in May, this follows price reductions of around 20% globally by the start of the year. That said, investors should focus on the big picture.
Electric vehicles (EVs) represented just 10% of new car sales in 2022. And Goldman Sachs estimates that this number will soar to 61% by 2040. With the industry still at a nascent stage, it makes sense for Tesla to focus on maximizing its long-term market share instead of profit.
The company does face significant competition from unprofitable rivals, such as Lucid and Rivian Automotive. But by keeping prices low, it can effectively prevent these companies from becoming a future threat to its business.
Image source: Getty Images.
Further, Tesla's price cuts may not have as much of a negative impact on margins as investors expect. In its investor day presentation, the company highlighted a plan to slash the prices of its next generation of vehicles by 50% -- a move that could support further price reductions while maintaining an industry-leading level of profitability.
What is next for Tesla?
Tesla investors should remember that, despite its luxury-adjacent brand, the company aims to become a mass-market automaker. Much of its operational cost savings will likely be passed on to consumers to maximize market share, leading to better economies of scale and more cost savings in the future. This strategy could reward investors much more than a low-volume, higher-margin model.
With a price-to-earnings multiple of 42, Tesla's stock trades at a premium valuation compared to the S&P 500 average of 24. But this looks justified when considering that the EV market is still in its early stages, and Tesla has all the tools it needs to dominate the opportunity.
