Banks kicked off earnings season nicely last week, with results largely coming in better than anticipated. But investors are still waiting to see how companies in many other major industries are performing. One company reporting earnings this week that investors will be watching closely is Tesla (TSLA -3.76%). A big question looms: Can the report live up to the stock's incredible 128% year-to-date gain? Or could the update disappoint investors?
As earnings approaches, some investors may wonder whether they should buy shares of the growth stock. While it's impossible to know how the stock will fair following Tesla's earnings release on Wednesday, there are several good reasons to refrain from buying it beforehand.
Recent price cuts will weigh on profits
We already know Tesla delivered an impressive number of vehicles in Q2. In its quarterly update on vehicle production and deliveries, the electric-car maker said it delivered a record 466,140 vehicles to customers during the quarter. This was up 10% sequentially and 83% year over year. But Tesla had to lower the price of vehicles significantly earlier this year to solicit this demand in a high interest rate environment. Some Tesla models saw price cuts as steep as 20%. This means that Tesla's profit will not grow in step with its revenue for Q2 due to lower margin on each vehicle than in the year-ago period.
Analysts, on average, are expecting Tesla's earnings per share to increase about 5% year over year to $0.68. This level of earnings growth would be far below the 83% growth in vehicle deliveries Tesla saw during the period. Given the steep price cuts Tesla had to roll out to grow deliveries at the rate it did, it may be wise for investors to wait for further updates from management on vehicle demand and profit trends before they consider buying the stock at its current price.
The stock's valuation may be too high
There's simply no reason to rush into a stock after such a big run-up. Some cooling off could be in order. Tesla shares currently trade at more than 80 times earnings -- a staggering valuation that prices in expectations for earnings to soar over the next five to 10 years. For further context, consider that Tesla's market capitalization of $891 billion dwarfs Ford's and General Motors' at about $60 billion and $56 billion, respectively.
Of course, Tesla's strong earnings growth will likely resume next year when the company starts running up against year-ago comparisons in which its price cuts were already in effect. As long as the secular tailwinds of the fast-growing electric-vehicle space remain robust and the company follows through on its plans to continue expanding production and to bring its new Cybertruck to market, management's expectation for deliveries to compound at an average rate of about 50% over a multi-year time horizon will likely play out. This would almost undoubtedly lead to rapid earnings growth.
But a high valuation that prices in strong earnings growth for years to come does little to account for risks of increasing competition or the capital-intensive nature of the auto industry -- something that could lead to profits growing more slowly than anticipated.
Bulls, of course, would argue that Tesla will likely generate substantial profits from its driver-assist software, particularly as the company moves ever closer to achieving autonomous driving. This could be true but investors may want to hope for a better price that does a better job of pricing in some risks before they buy shares of the electric-car maker.
Tesla reports second-quarter results after market close on Wednesday, Jul. 19. Management will host a live question-and-answer session with analysts to discuss its quarterly results at 5:30 p.m. ET.
