For the second quarter, Tesla (TSLA -0.05%) reported revenue of $24.9 billion, which was a 47% increase versus the year-ago period. That growth is impressive without a doubt, particularly given the macroeconomic headwinds and higher interest rates. Moreover, last quarter's sales exceeded Wall Street expectations. 

But it wasn't all good news for the leading electric car (EV) company. Tesla's profitability is taking a noticeable hit, and things could be challenging as we look toward the future. 

Here's what investors should know before deciding if they should buy this top auto stock. 

Shrinking margins 

In Q2 2022, Tesla achieved a gross margin of 25% and an operating margin of 14.6%. Those levels of profitability are unheard of in the auto industry among mass-market manufacturers. For example, Ford, which is investing heavily in its own EV capabilities, registered a gross margin of 11.1% and an operating margin of 5.1% during its most recently reported quarter. GM's margins are in the same ballpark. 

However, Tesla's margins have contracted significantly due to to the numerous price cuts its management team implemented, as well as the discounts and incentives the company has offered. During Q2, Tesla's gross margin fell to 18.2% and its operating margin was down to 9.6%. Declines like those are not what shareholders like to see. 

Lower selling prices for vehicles unsurprisingly impacted profits. Tesla reported net income of $2.7 billion in Q2. While that was up 20% year over year, its bottom-line growth rate was substantially less than its top-line gain. 

Founder and CEO Elon Musk has explained that the point of these price reductions is to boost unit volumes of its popular EVs in support of its efforts to continue gaining market share. Tesla delivered 466,000 EVs in the second quarter, 83% more than it had in the prior-year period. That's certainly an encouraging sign. 

The flip side to this argument, though, concerns the intensifying competition in the EV space. Ford and GM have entered the fray, there are compelling EV options from numerous international players, and several start-ups have models in production. It's possible that Tesla is experiencing demand pressures that compelled Musk to adjust prices. 

Declining margins aren't something to cheer about, but if Tesla can rapidly increase vehicle deliveries in the next several quarters, that could be viewed as a sign that the price cuts are working as intended. And if the company's margins stabilize, that would suggest that the business is benefiting from operating leverage as its manufacturing capabilities scale further. 

In other words, Tesla would be able to charge less for its EVs and still profit because it would be able to produce them at lower cost. Only time will tell whether its pricing strategy ends up being a net benefit to the company. 

Expensive valuation 

Investors will struggle to find a better investment success story over the past 10 years than Tesla. Its shares have soared by 1,260% in the last five years and 3,220% in the last decade. 

After that impressive run-up, the stock currently trades at a trailing price-to-earnings ratio of 76. That's a much higher valuation than you'll find elsewhere among its peer group, and prices in lots of optimism about the company's future. 

It ultimately comes down to how you view things as an investor. Tesla bears have a valid argument for saying that the stock is priced for perfection. And considering the way the company's margins are trending, as well as the state of the competitive landscape for EVs, it might be best to avoid the stock. 

But if you're OK with these factors, then buying shares in the clear industry leader seems like an easy decision to make.