U.S. companies have created more value for their investors than those of any other nation throughout history. The country's commitment to free markets empowers the cream to rise to the top, and several different industries have led the economy forward at different points in time:
- In 1901, United States Steel became the first company in the world to achieve a $1 billion valuation.
- By 1955, cars were driving economic growth and General Motors became the first ever company to amass a $10 billion valuation.
- By 1995, industrial conglomerate General Electric became the world's first $100 billion company by selling everything from airplane engines to household appliances.
- But in 2018, Apple achieved the next great milestone. The technology giant rode the sales of its blockbuster iPhone to a $1 trillion valuation.
Apple remains the world's largest company, and it recently exceeded a $3 trillion valuation. It has since been joined in the exclusive $1 trillion club by Microsoft, Amazon, Google parent Alphabet, and Nvidia.
There is another company on the way to re-gaining membership in this club (it held membership for brief periods in 2021 and 2022). Tesla (TSLA 6.66%) is a global leader in electric vehicle (EV) sales, but it looks set to ride the artificial intelligence (AI) wave to substantial value creation in the coming years.
The company just released its financial results for the third quarter of 2023 (ended Sept. 30), and while investors immediately sold the stock, here's why that's a long-term buying opportunity.
Image source: Tesla.
Tesla is navigating a changing landscape for EVs
Tesla has always led the EV industry with its technology, not only in its cars but also in its production process. As a result, the company produces each vehicle with a much higher gross profit margin than any other car manufacturer, including those still making internal combustion-powered vehicles.
But Tesla faces challenges at the moment. First, elevated inflation and rising interest rates are forcing consumers to tighten their belts, which means they're purchasing fewer big-ticket items like new cars. Second, competition is growing from specialist EV start-ups and from leading brands like Mercedes Benz, General Motors, and Ford, which have entered the EV race.
Tesla is combatting those headwinds by slashing the price of its vehicles. In fact, according to Cox Automotive, a new Tesla is 19.5% cheaper now (on average) compared to August 2022. The company has more room to reduce prices than its competitors because of that high gross profit margin I mentioned earlier. In Q3, it was 17.9%, which still leads the automotive industry. But that's down from 25.1% a year ago.
Lower prices are denting Tesla's financial results
Price cuts appear to be spurring demand. Tesla delivered 435,059 cars in Q3, which was a 27% increase year over year, despite disruptions caused by planned production shutdowns in Europe and China for equipment upgrades.
However, the lower price per vehicle meant automotive revenue only climbed by 4.5%. While Tesla remained profitable for the quarter, its net income (profit) plunged by 43.6% as price cuts left less meat on the bone to absorb operating expenses.
Data source: Tesla. Infographic by The Motley Fool.
The silver lining is that despite all of the aforementioned challenges, Tesla hasn't reduced its production forecasts. The company still expects to manufacture 1.8 million vehicles in 2023 as planned, and it reiterated its goal to grow that figure by 50% per year for the foreseeable future.
But here's what long-term Tesla investors should be focusing on
While investors get caught up in the ebb and flow of Tesla's delivery numbers, it's important to keep in mind this is a technology company, not a run-of-the-mill car manufacturer. For example, Tesla has been working on autonomous driving software for years, which could transform the economics of each vehicle sold.
Full self-driving (FSD), as Tesla calls it, is underpinned by artificial intelligence. Its models are trained on real-world data collected by Tesla customers using the software in beta mode right now. As of Q3, CEO Elon Musk said they had completed over 500 million miles in total.
FSD software could be ready for mainstream release by the end of this year, according to Musk. Tesla will sell it to each customer on a subscription basis, and since software can be developed once and sold an unlimited number of times, it has a very high gross profit margin of up to 80%.
Additionally, Musk wants to build a ride-hailing network for Tesla's autonomous vehicles. He says the average passenger car is only used for 12 hours per week, and it could spend the rest of the time serving as a self-driving robotaxi to earn income for both the vehicle owner and Tesla.
Musk believes selling FSD software and operating the autonomous ride-hailing network could eventually increase Tesla's gross profit margin to 70%, from 17.9% today. He has previously said Tesla could sell each vehicle at a break-even price and still make significant amounts of money from the software ecosystem, so it can afford to continue slashing prices whereas its competitors can't.
Autonomous vehicles could catapult Tesla into the $1 trillion club
Tesla is currently valued at $760 billion, which means its stock only has to climb by 32% for the company to join the $1 trillion club. Based on its $3.61 in trailing-12-month earnings per share, its stock currently trades at a price-to-earnings (P/E) ratio of 64.3.
Keep in mind the company's earnings will fall if it continues to slash prices, making its P/E ratio look more expensive (and it's already trading at twice the P/E of the Nasdaq-100 index).
But hypothetically, if Tesla's pricing and its P/E ratio remained constant going forward, the 50% annual production growth rate projected by the company would be enough to push it into the $1 trillion club within the next year. But it gets better.
Industries like autonomous ride-hailing are still in the very early stages, but some Wall Street firms have begun modeling its financial potential. Ark Investment Management, which is run by Cathie Wood, believes it could generate $4 trillion in revenue by 2028. The firm says adoption could be rapid thanks to autonomous vehicles significantly reducing the cost per mile of mobility (operators don't have to pay drivers, which reduces costs).
It's the reason Ark predicts Tesla will be worth a mind-boggling $6.1 trillion by 2027. That would require a stock price of $2,000, implying an 860% gain from where it trades today. The firm's estimates are quite ambitious because they rely upon Tesla's revenue growing by 65% per year for the next four years, which is far higher than the company's own projections (mentioned above).
Nevertheless, even if Tesla doesn't join Apple, Microsoft, Amazon, Alphabet, and Nvidia in the $1 trillion club within the next 12 months, it might be a foregone conclusion over the longer term.
