With a market cap hovering around $800 billion, investors are pushing Tesla (TSLA -2.04%) toward a return to the $1 trillion club. The innovative automotive manufacturer certainly has the prerequisite characteristics of one, including a secular tailwind, a culture of disruption and innovation, and a truly huge market opportunity. But share prices have already climbed so much in a relatively short time. Investors concerned about paying too much have a lot to think through before making a move.
So, is Tesla stock a buy right now? Let's take a closer look at the market leader in electric vehicles (EVs).
The potential for greater profitability
Tesla has a truly monstrous lead in the EV industry in the U.S., which has helped build up the company's economic moat. Key to Tesla's success is its strong brand, which it helped build by first focusing on the high end of the market. Its cars are considered high-tech, and the ability to service them for some issues with just a software update offered an improved customer experience. Despite little to no traditional marketing efforts, Tesla has a standing as a luxury item.
Another advantage Tesla has, thanks primarily to its first-mover advantage, relates to technological know-how. Having been the clear leader in the industry for about a decade now, Tesla has gained some clear expertise in manufacturing capabilities, vehicle software, and vehicle hardware design. This is an edge it's trying to grow.
These key attributes help Tesla succeed even as it sees more competition. Pretty much every other automaker has entered the EV race, but none are as profitable as Tesla.
Looking ahead, CEO Elon Musk claims Tesla's income potential will be truly massive. Part of that potential is related to Tesla's efforts to develop fully autonomous vehicles. If this becomes a reality, Musk sees Tesla launching a robotaxi service that is projected to generate outsized profitability.
Famed investor Cathie Wood and her firm, Ark Invest, agree with Musk's assessment. In Ark Invest's bull-case scenario for Tesla, the automaker will generate more revenue from an autonomous ride-hailing service in 2027 than from selling EVs, with the company's gross margin exceeding 50%. It's projections like these that support the investment firm's price target of $2,500 per share by then. Of course, these are just (ambitious) projections, but it does suggest there is more than just average potential being discussed.
Competition is heating up
I mentioned how Tesla stands out against rivals, but that doesn't mean competition is something investors shouldn't worry about. Numerous players are all vying for a piece of the burgeoning EV market. In the U.S., Tesla has to think about legacy automakers, like Ford Motor Company and General Motors, as well as younger companies Lucid Group and Rivian Automotive.
It doesn't get any easier on the international stage. China has some formidable opponents in Nio, Li Auto, and BYD. In fact, the Chinese EV market is further along its maturation stage than the U.S., with greater unit sales. Plus, the country's huge population supports growth.
Understanding that the competitive landscape is only going to get more difficult, Tesla has implemented numerous price cuts for its vehicles to continue growing its market share. This has led to contracting margins, something investors should pay close attention to going forward.
What about the valuation?
Because Tesla shares have absolutely skyrocketed in the past five years, investors are being asked to pay a hefty price-to-earnings (P/E) ratio of 73.6. Conservative and value-focused investors might immediately be turned off by such a steep valuation, which is understandable. Tesla would have to grow into those lofty expectations, and that requires an extremely bullish outlook.
It's hard to bet against Elon Musk, but for a company with such a huge market cap and a stock selling at a high valuation, the optimism might be fully priced in. And investors have to really question whether market-beating performance is achievable over the next five to 10 years. I think it might be a good idea to wait for a pullback before buying.
