It's no secret that Tesla (TSLA -1.11%) commands a premium valuation. With a market capitalization of $835 billion, the company is worth as much as the next nine automakers combined. Some investors simplify cannot fathom the reason for that premium, but CEO Elon Musk thinks the answer is artificial intelligence (AI) -- or more precisely, the full self-driving (FSD) platform the company is developing.
Musk recently called autonomous vehicle technology the "main driver " behind the immense brand value Tesla enjoys. And he believes its FSD platform -- which is made up of proprietary software and hardware -- will ultimately be the most important source of profitability for the company.
Here's what investors should know.
Image source: Tesla
Robotaxis promise to revolutionize the world
Autonomous vehicles promise to revolutionize mobility and logistics by replacing fallible humans with less fallible artificial intelligence (AI) software. Robotaxis will make car ownership optional, reduce motor vehicle-related deaths, and improve human productivity by freeing up time previously spent behind the wheel. Similarly, autonomous trucks will improve cargo transport by increasing safety, reducing labor costs, and sidestepping human inefficiencies, like the need to sleep.
Many people still see self-driving cars as being straight out of science fiction, but some experts predict explosive growth in the near future as the industry barrels toward becoming mainstream. The consultant agency McKinsey estimates that robotaxis will account for 8% of global transportation by 2035, up from roughly zero today. And Ark Invest says autonomous ride-hailing platforms could generate $9 trillion in revenue by 2030. That puts investors in front of a monumental opportunity.
Tesla is an early leader in autonomous vehicle technology
Tesla is far from the only company working on self-driving vehicles, but it does have two noteworthy advantages. First, Tesla has more autonomous driving data than other automakers because its fleet of autopilot-enabled cars is larger. That data advantage hints at superior FSD software because training data is the foundation of good AI. Second, Musk believes the in-car supercomputer Tesla engineered for its FSD platform is the "most efficient inference computer in the world."
As a caveat, Tesla has yet to perfect its FSD platform, but Musk says its engineering team will "solve autonomy soon," and the company plans to mass-produce a robotaxi in 2024. That means Tesla may be a few short years away from starting an autonomous ride-hailing service, which will dramatically increase its total addressable market.
As mentioned, Ark Invest estimates that autonomous ride-hailing platforms will generate $9 trillion in revenue by 2030. That figure is several times bigger than the $1.1 trillion in electric vehicle sales that experts expect in the same year.
Additionally, software and services (e.g., FSD software and autonomous ride-sharing services) tend to come with much higher margins than hardware (e.g., electric vehicles). That means Tesla should become increasingly profitable in the future, which is especially noteworthy because it already has the highest operating margin among volume carmakers.
The big picture for investors
Tesla is the leader in battery electric vehicles, with nearly 24% market share in the first quarter, and the company reported the highest operating margin among volume automakers last year. Musk attributes that achievement to unmatched manufacturing capabilities. For instance, Tesla can produce battery packs at a lower cost per kilowatt-hour than other automakers. And future innovations promise to further improve margins.
Tesla plans to implement a new vehicle assembly process at its Gigafactory Mexico in 2024. According to management, the new system could cut production costs in half and reduce its factory footprint by 40%. Tesla is also evolving toward software and services, both of which offer higher margins than auto manufacturing.
All this means Tesla's revenue should grow quickly in the coming years as electric vehicles and autonomous vehicles become more prevalent, but the company should also become increasingly profitable as manufacturing innovation drive margin expansion and FSD software and autonomous ride-hailing services account for more of total revenue.
Tesla stock is worth the risk (for some investors)
Shares of Tesla currently trade at 10.5 times sales, a slight discount to the five-year average of 10.9 times sales, but still an exorbitant valuation multiple compared to other automakers. Shares of Ford and Toyota currently trade at 0.3 times sales and 0.8 times sales, respectively.
Here's the bottom line: Tesla is not for the faint of heart. The stock will likely be volatile in the near term due to its valuation, and shares could fall sharply during a recession. But its current valuation may appear cheap in hindsight if the company is successful with its push into software and services.
For that reason, risk-tolerant investors who believe Tesla is on the cusp of solving autonomy should consider buying a few shares of this AI growth stock today. But investors that lack confidence in the robotaxi narrative should put their money elsewhere.
