The electric vehicle (EV) industry is changing quickly. Just a few years ago, Tesla (TSLA -1.11%) was essentially the only major player in the U.S. and rode that first-mover advantage to generate operating margins approaching 20%.
But these days, Tesla is competing in EVs against legacy automakers like GM and Ford, European carmakers like Volkswagen and Polestar, as well as upstarts like Rivian Automotive (RIVN 6.10%) and Lucid Group (LCID 0.41%).
In response to the new wave of competition, Tesla has announced multiple price cuts in recent months, signaling that the company would rather gain market share than generate higher profits. And CEO Elon Musk suggested that the company could even generate zero on car sales and make it up by selling services like full self-driving to owners.
If you're wondering what to make of the changing EV industry as an investor, you might want to heed the words of Warren Buffett, the CEO of Berkshire Hathaway (BRK.A -0.76%) (BRK.B -0.69%) and the most successful investor of all time.
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Buffett's wise words
Berkshire Hathaway hasn't ignored the EV market. In fact, the company was a major investor in Chinese EV maker BYD, though Berkshire has been selling off its stake over the past year.
Asked why at Berkshire's annual meeting, Buffett and Berkshire's vice chairman, Charlie Munger, said they didn't want to compete with Elon Musk. But there's another reason the company has been steering away from BYD, and why Buffett is unlikely to buy another EV stock.
At the meeting, he essentially told investors that there would be no leader in the EV market, saying, "You will see a change in the vehicles, but you won't see anybody that owns the market because they changed the vehicle."
Buffett makes a good point. There are a number of factors right now that make EVs a challenging sector for investors. Competition is intensifying, and legacy automakers aren't going to disappear. Currently, the auto market is fragmented, and the EV market seems unlikely to be different as more entrants join the market and prices come down, a reflection of increasing competition.
Matching production with demand is also a much harder problem in automobiles than it is with software or even smartphones, and a mismatch can easily lead to discounting -- or profits left on the table if production levels are too low.
Another problem is that there are still billions of dollars sloshing through the industry as investors previously bid EV stocks up to stratospheric levels. Rivian, for example, still has more than $11 billion in cash on its balance sheet, and start-ups with cash to burn will only make it harder for other companies to generate a profit.
Incumbents like GM and Ford, meanwhile, don't need to make a profit in EVs yet and are more focused on establishing their brand and gaining share in the new market, which will also put pressure on industrywide profitability.
The ride-sharing and food delivery industry suffered from this problem earlier. Companies like Uber, DoorDash, Lyft, and Grubhub spent billions on incentives in a fight over market share for years, which mostly crushed the stocks before they more recently reined in costs and took steps to profitability.
While Tesla is solidly profitable, the company's willingness to lower prices to fend off competition shows that those margins might not last.
A successful industry isn't the same as a successful stock
EVs might be the future in the auto industry, but that's different from the stocks being good investments. During the dot-com boom, Buffett said that in the first half of the 20th century, the automobile and the airplane represented similarly transformative inventions, but investing in those industries at that time would have been a fool's errand since most of those companies went bankrupt.
EV stocks might not be about to go bankrupt, but that doesn't make them immune to the cutthroat dynamics of an emerging industry. Competition is likely to intensify and profit margins look set to get squeezed. Investors might want to listen to Buffett's words and tread lightly in the EV sector.
