Tesla (TSLA 0.66%) remains the clear-cut leader in the electric vehicle (EV) market, but its stock has seen some volatile trading in recent years. Notably, the EV leader's share price is still down roughly 35.5% from the all-time high it hit in November 2021.
But while the stock is down big from its peak, CEO Elon Musk's vehicle manufacturer actually turned an important corner that year and continues to deliver an encouraging performance. The data in the chart below offers some clues as to why that is. Let's take a closer look at what this information from data specialist New Constructs shows and see what it might mean for Tesla's investors.
Strong ROIC performance supports a bull case for Tesla
The chart above tracks the growth of Tesla's return on invested capital (ROIC) in comparison to the growth of its weighted average cost of capital (WACC). The WACC metric reflects how much the company's capital costs between debt and issuing stock in relation to its market capitalization and also factors in its corporate tax rate because interest expenses are deductible. Weighted average cost of capital can be used as a way to determine the minimum rate of return on an investment that would be acceptable.
On the other hand, ROIC is a metric that can show how efficiently a company is able to turn cash used into profit. As the return on invested capital goes up, a proportionally increasing amount of profit is generated from each dollar that is put into the business.
In short, an ROIC rate that is far above the WACC rate is a good sign. As shown in the chart, Tesla turned a corner on that front in 2021 and continues to serve up encouraging results.
WACC grew 20% annually to reach 10% in 2022, while ROIC jumped roughly 78% to hit 29.6%. Even with Tesla's return on invested capital dipping to 23.6% over the trailing 12-month period concluding at the end of this year's second quarter, the business's ROIC remains far above its 13% WACC across the stretch.
Tesla's WACC has climbed in recent years in conjunction with new shares being created, rising interest rates, and other changes. But progress for its ROIC has been much more pronounced, and this can be interpreted as a bullish signal for the stock.
Where does Tesla go from here?
In general, Tesla's ROIC performance in relation to its WACC suggests that it's running an efficiently profitable business and effectively managing its costs and capital structure. The recent dip in ROIC can be partially attributed to the company's discounting initiatives. In order to increase sales, Tesla implemented significant price cuts for its vehicles. This has resulted in the company's gross profit and operating income margins declining.
For example, the company's 9.6% operating income margin in this year's second quarter was the lowest posted by the business in the last five quarters. The company's 18.2% gross margin in Q2 was also the lowest it had been in five quarters.
At the same time, Tesla has continued to grow sales and earnings at an impressive pace. The company grew revenue by 47% in this year's second quarter to reach $24.9 billion despite soft demand in the broader auto industry, and net income rose 20% to hit $2.7 billion.
Given the historically cyclical nature of the auto industry, some aggressive price cuts on its vehicles, and investments in long-term growth initiatives beyond auto sales, it's reasonable to expect that Tesla will see some fluctuations with its margins and ROIC.
Even with some recent declines, the EV leader continues to enjoy strong margins in the context of the broader automotive industry. The company has been flexing its pricing power and aiming to strengthen its market share with recent pricing cuts, and this strategy could pay off over the long term.
Is Tesla stock a smart buy right now?
Tesla currently trades at roughly 73 times this year's expected earnings and 8.3 times expected sales. This is a heavily growth-dependent valuation -- particularly for a company operating in the heavily competitive automotive industry. But the EV leader's valuation picture should be viewed in context.
TSLA PE Ratio (Forward) data by YCharts
In addition to signs that Tesla generally has its long-term ROIC performance on the right trajectory, Musk continues to invest heavily in potentially disruptive growth bets. Tesla aims to be much more than just a car company.
For example, Ark Invest CEO Cathie Wood said she believes that the self-driving taxi market will generate between $8 trillion and $10 trillion in annual global revenue by 2030 -- and Tesla has positioned itself as a top player in this emerging industry. For those looking to capitalize on the growth of the EV market and tap into potentially explosive opportunities in self-driving taxi services, Tesla stands out as a top investment vehicle.
Admittedly, there's a heavy degree of speculation involved in charting how Tesla's bets on self-driving technologies and other innovations will pan out. But encouraging ROIC performance for its core EV business and the potential for other powerful growth drivers suggest that the stock could be a worthwhile portfolio addition for risk-tolerant investors.
