Shares of Tesla (TSLA -0.35%) seem to mostly move in only one direction recently: up. The growth stock received another big boost on Tuesday as electric vehicle company Rivian Automotive said it is adopting Tesla's North American Charging Standard (NACS).
In total, Tesla's stock is up an astounding 49% over the last 30 days. With such a sharp rise, shareholders are in a bittersweet position in which they're likely extremely pleased with their gains, but may have doubts about whether or not they should continue to hold shares of the stock. With Tesla stock trading so much higher than it was just a few weeks ago, it's a good time to review the growth stock's valuation and the underlying business to see if investors should take some profits off of the table.
A tipping point
Investors seem to be viewing manufacturers' willingness to adopt Tesla's charging standard as a tipping point for electric vehicles and evidence of Tesla's leadership in the space. Rivian's move to enable its vehicles to access Tesla's charging network, starting next year, follows similar moves from General Motors and Ford Motor Company in recent weeks.
The view that there's a tipping point occurring in electric vehicles has some substance. Consider that even though total global passenger vehicle sales contracted slightly in 2022, Tesla's deliveries increased 40% year over year. Investors should appreciate this strong growth rate for several reasons. First of all, with its total deliveries at more than 1.3 million in 2022, Tesla is no small player anymore. Second, this occurred despite an uncertain macroeconomic environment and significant supply chain challenges throughout the year.
Tesla's momentum has persisted into 2023, with first-quarter deliveries rising 36% year over year. Sure, the company needed to lower its prices substantially in order to offset the potential substantial slowdown in demand that could have occurred due to rising interest rates. But the fact that Tesla can lower its prices substantially is another reason to believe a tipping point for electric cars is here. Tesla's more affordable fully electric cars produced in increasingly higher volumes with access to a shared charging standard sounds like a recipe for a tipping point toward more meaningful mass-market adoption.
Valuation risk
Despite some good reasons to be bullish on Tesla's business, the stock's valuation is a concern. With a price-to-earnings ratio of 79, investors are pricing in strong business growth for years to come. While recent underlying performance suggests the company can live up to this valuation, the automotive market is extremely competitive. Investors should leave room in their valuation models for the risk of the capital-intensive and highly competitive automotive industry leading to potential problems in the future, including the possibility of Tesla's earnings not growing as fast as anticipated.
According to investment research and stock analysis company New Constructs, the market's expectations for the time Tesla can maintain an edge over competitors, evidenced by its ability to earn a higher return on invested capital than its weighted average cost of capital on new investments, are simply too bullish. The firm calls this duration in which a company can sustain a lead over competition a "growth appreciation period." New Constructs believes investors' expectations for Tesla's growth duration period are too optimistic, leaving significant room for error in the market's forecasts.
While this is just one analyst's opinion on the stock and investors should do their own due diligence, New Constructs does bring up a good point: The current price for Tesla shares bakes in some incredibly high expectations from the business over the long term. With the valuation looking expensive, it may be wise for some Tesla shareholders to sell some of their shares.