Since falling to a 12-month low of $102 about seven months ago, Tesla's (TSLA +0.30%) stock has made an extraordinary recovery, surging by more than 150% to trade at $269 (as of writing). That put it back to about the same level it was trading at a year ago.
While little has changed for the company in the last few months, growth investors' interest in Tesla's stock was probably renewed after the significant beating it took in 2022, which cut its value by about two-thirds.
But before following the crowd into the stock now, investors should be mindful of two significant risks that could cause them to lose money in this investment.
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Tesla's price-cutting strategy has risks
Tesla has been a star over the last few years, repeatedly delivering record-breaking top- and bottom-line performances. But in 2023, most investors have expected the carmaker would experience a slowdown amid a more challenging macroeconomic environment.
Sure enough, Tesla's first-quarter results showed some weakness -- revenue and operating profit were down from the preceding quarter. That weakness continued in the second quarter. While revenue came in 47% higher year over year, operating income fell by 3% thanks to a significant contraction in the operating margin, which fell from 14.6% to 9.6%. In other words, Tesla might be selling more cars, but it's making significantly less profit per car.
While Tesla bulls may argue that its lower margins are the intentional result of a pricing reduction strategy it initiated to help increase its market share, Tesla bears have concerns about the risk inherent in such a strategy. For instance, Tesla might expand its capacity when it should withhold production -- since it anticipates that its price reduction strategy will lead to higher sales volume. Doing that could lead to excessive operating leverage, which would be detrimental in a recession.
Besides, while a low-price strategy could boost sales volume in the near term, such a strategy may not work if the economic environment worsens further. As cars are high-priced discretionary items, consumers may choose to defer purchasing them in a recession. And if that happens, Tesla's low-price strategy could even backfire since it's earning less on each car it sells.
And herein lies the risk. Car manufacturers like Tesla have enormous fixed costs built into their cost structures. So a decline in sales volume will disproportionately affect Tesla's profitability. Worse, if its sales volume falls below a certain level, it may become unprofitable.
Lest we all forget, despite its good prospects, Tesla is still a car manufacturer (at least in the near term).
NASDAQ: TSLA
Key Data Points
The stock's premium prices in a lot of optimism
Investors already have to face Tesla's profitability risk in the near term, but its highly valued stock adds another layer of risk. Tesla's stock trades at a price-to-sales ratio of 9.9 while its longer-established peers like General Motors and Ford trade at less than 0.4 times sales.
Of course, the bulls may argue that Tesla is not a conventional car manufacturer and should be valued more like a technology company. But even a leading technology company like Alphabet only trades at a price-to-sales ratio of 5.6. Comparatively, Tesla's stock now carries a considerable premium.
There are good reasons to be optimistic about Tesla's long-term prospects as it benefits from major tailwinds in EVs, renewable energy, robotics, and autonomous driving, among others. But the fact that it is a good company (with good prospects) doesn't necessarily make it a good investment, especially if investors have priced all of the medium-term reasons for optimism (and then some) into its shares.
As the old saying goes, price is what you pay, and value is what you get. Investors can expect to receive very little value from Tesla's stock if they buy it at this price.
