One of the reasons Tesla (TSLA 12.06%) has been a trendy stock pick is its tendency to break all of the rules established by traditional automakers. Whether by solely offering electric vehicles (EVs), forsaking the dealer network model, using a non-union workforce, or not advertising, Tesla has disrupted the auto industry.
However, Tesla is about to back away from one item it has consistently not done: advertise its products. So how will this affect Tesla, and should investors be worried? Let's find out.
Tesla has a basic message to get out
CEO Elon Musk said at Tesla's annual shareholder meeting: "We'll try a little advertising and see how it goes." As investors, this could be seen as a huge red flag or a kind of small green flag.
On the red flag side, if Tesla needs to advertise, it clearly indicates falling demand for its product. With Tesla's premium valuation, the stock can't afford having the business's growth slow down, and this strategic shift may be writing on the wall for Tesla.
However, part of the reason for this advertising campaign is to get the word out that Tesla's models aren't as expensive as one might think. During the meeting, it was brought up that the average starting price of Tesla's models is less than the average car price in the U.S. If a small ad campaign can shed light on this fact and change consumer sentiment, this could create even more demand for Tesla and provide the growth the company is looking for.
It's unclear how much Tesla will spend on advertising, but looking at competitors' budgets may be a good place to start.
Tesla may be giving up some of its margin advantages
Ford has a massive ad budget, spending $2.2 billion in 2022 and $3.1 billion in 2021. After subtracting the cost of revenue, Ford's gross margins were $14.4 billion in 2022. That means Ford's advertising budget eats up about 15% of its gross profit.
Shifting back to Tesla in 2022: It made a gross profit of $20.9 billion. It's worth noting that Tesla produced a significantly higher gross profit than Ford despite having only 52% of the revenue.
If Tesla decided to spend 15% of its gross profit on advertising, it could drop $3.1 billion on this line item. Now I think that's highly unlikely, as Musk indicated they would only "try a little." Still, advertising can eat through money quickly.
Investors might see the effects of advertising soon through personal experience or in second-quarter results, but how it will work out for Tesla is unknown. It all boils down to the motive behind advertising: Is it education or a last-ditch effort to create some demand for its cars?
With Tesla's current stock valuation, the bulls are still winning this argument, so the positivity hasn't left yet. However, should Tesla experience falling sales even with advertising, some investors may exit the stock for fear of Tesla reverting to a usual automaker's habits.
Personally, I'm in the camp that a bit of advertising will likely help Tesla. Musk is pretty intelligent about the workings of a business and has led Tesla well so far. I think the news of Tesla starting to advertise is more noise than signal, but investors will be able to know for sure by examining the future quarterly results.
