Wall Street offers few guarantees, other than unpredictability. The smartest investors on Wall Street will be lucky if they're right around 60% of the time.
Nevertheless, Wall Street analysts, pundits, and money managers are often looked up to by investors as people with an above-average understanding of the companies, industries, and sectors they cover. In other words, there's a built-in expectation that individuals with a Wall Street connection are going to outperform and be right more often than the average investor. But this isn't always the case.
In many instances, analysts reactively, rather than proactively, adjust their firm's price target on a stock. Despite their stock-specific and industry know-how, Wall Street analysts are just as fallible as everyday investors.
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A working paper ("Diagnostic Expectations and Stock Returns") from four authors -- Pedro Bordalo, Nicola Gennaioli, Rafael La Porta, and Andrei Shleifer -- that was updated in September 2017 compared the performance of stocks that analysts were most optimistic about to the performance of companies with the most pessimistic takes. The study, which examined calls from 1978 to 2016, found that stocks with the highest convictions earned average returns of only 3%, while those with the most pessimistic forecasts had an average return of 15%.
While some Wall Street price targets are enough to make investors roll their eyes in disbelief, one, in particular, stands out as being otherworldly. There's absolutely no doubt in my mind that it's Wall Street's most ridiculous price target.
Wall Street's most absurd price target
In April, Ark Invest, the investment firm headed by Cathie Wood, issued a jaw-dropping price target of $2,000 by 2027 for electric-vehicle (EV) manufacturer Tesla (TSLA -0.57%). When issued, it implied more than 1,100% upside in Tesla's shares, along with a market cap of $6.3 trillion. For some context, Apple is currently the largest publicly traded company in the U.S., with a market cap of roughly $3 trillion.
According to Ark Invest's Monte Carlo analysis, Tesla is on track to reach $1.02 trillion in annual sales by 2027, with $354 billion in annual earnings before interest, taxes, depreciation, and amortization (EBITDA). Ark's $2,000 price target infers that 47% of Tesla's $1.02 trillion in sales will come from its EVs, with another 44% of sales derived from robotaxis. However, 64% of the aforementioned $354 billion in forecast EBITDA in 2027 is projected to come from robotaxis.
In some ways, Tesla has merited a premium valuation. It's the first automaker in more than a half-century to have successfully built itself from the ground up to mass production. It's also the only pure-play EV maker that's generating a recurring profit, based on generally accepted accounting principles (GAAP). While legacy automakers are profitable, their EV divisions are still, collectively, years from the turning the corner to recurring profits.
But if investors dig beneath the surface and go beyond these first-mover advantages for Tesla, they'll see just how ridiculous a $2,000 price target actually is.
Tesla's key performance indicators are deteriorating
Although Tesla possesses a majority share of EV sales in the U.S., it's just as susceptible to competitive headwinds as any other automaker.
Since the start of 2023, Tesla has reduced the price on its lineup of EVs on a half-dozen occasions. While optimists and EV enthusiasts had previously opined that these price cuts were being passed along due to realized production efficiencies and Tesla's desire to steal share from its competitors, CEO Elon Musk noted during Tesla's first-quarter conference call that the company's pricing strategy was determined by demand. If the company is cutting prices, it's because demand for EVs has weakened and/or Tesla's inventory levels are climbing.
Though cutting prices has helped Tesla move some of its EVs, it's come at a cost to the company's automotive gross margin and operating margin. The June-ended quarter saw the company's automotive gross margin, excluding regulatory credits, dip to about 17%. Meanwhile, Tesla's operating margin has been nearly halved in the past four quarters, from 17.2% to 9.6%. With competition picking up from new and legacy automakers, there doesn't look to be any margin relief in sight.
Full autonomy is no closer to becoming a reality for Tesla
One of the wildest prognostications from Wood and her team is the belief that autonomous robotaxis would account for approximately $450 billion in full-year sales and around $225 billion in full-year EBITDA in 2027. At the moment, Tesla has exactly zero robotaxis on the road.
In each of the past 10 years, Elon Musk has opined that Level 5 full self-driving (FSD) was "one year away." But as you can tell by the fact that Tesla doesn't have a single robotaxi on the road and is currently stuck at Level 2 autonomy, Musk and his engineers are no closer to solving full autonomy than they were a decade ago when Musk first insinuated that Tesla's EVs would drive themselves.
Although Ark Invest does have a bear case (a $1,400 share price by 2027), it still calls for $200 billion in annual sales from autonomous robotaxis in 2027. For context, the global ride-hailing and taxi market only amounted to just shy of $200 billion in 2021, according to Straits Research. It's unlikely we see this figure expand much by 2027, which makes even Ark's bear case and expected value models even more unrealistic.
From left to right, a Tesla Model S, Model, 3, Model X, and Model Y, parked at a supercharger station. Image source: Tesla.
Efforts to become more than a car company have failed
To build on the previous point, Ark Invest's Monte Carlo analysis implies that Tesla is going to be much more than just a car company. From autonomous vehicles to its variety of energy, storage, and service products, such as residential/commercial battery packs and its supercharger network, there's the belief by Cathie Wood and her team that Tesla can command a truly premium valuation.
The problem is that all efforts by Tesla to become more than just a car company have, thus far, failed. Energy and storage revenue actually declined by about 1% in the June-ended quarter from the sequential first quarter. Meanwhile, the margins associated with energy, storage, and services tends to be rather low. The point being that Tesla is almost entirely dependent on selling and leasing EVs for its profits... just like every other automaker.
Traditionally, automakers trade at 6 to 8 times trailing-12-month (TTM) earnings. That's because the auto industry is highly cyclical and tends to ebb and flow with the health of the U.S. economy. Even after the drubbing Tesla took the day after releasing its second-quarter report, the company is still trading at 66 times TTM earnings.
Even if Tesla retains some of its first-mover advantages, a price-to-earnings ratio of 66 on an automaker with declining automotive gross margin is virtually impossible to support. Ultimately, Tesla would be lucky to sustain a valuation that's even one-tenth of the ridiculous $2,000 price target issued by Cathie Wood's Ark Invest.
