With a trailing-10-year return of 2,560%, it goes without saying that Tesla (TSLA 0.66%) has been one of the best investments anyone could've made. Even this year, shares are up a whopping 98%, crushing the broader market by a wide margin.
This electric vehicle (EV) stock currently trades 41% below its peak price of $410, which was established in November 2021. But some bullish investors might have their sights set on $500 per share. This lofty target would imply a more than 100% gain from today's price.
Tesla's stellar past performance means that this milestone might not be out of the question, even as soon as 2024. Let's see what needs to happen for the stock to hit $500 by the end of next year.
Investors want to see fundamental improvements
Over the long term, a stock's returns are based on how well the underlying business is performing. In Tesla's case, throughout its history, growth has been the key driving force. Spearheading the EV movement not only in the U.S. but across the world has led to rapidly increasing sales.
But things have slowed down noticeably in 2023. In the latest quarter (Q3 2023 ended Sept. 30), Tesla's revenue increased by just 9%, a far cry from the monster double-digit growth the company has typically registered.
Elon Musk blames the unfavorable macroeconomic environment. Buying a new car is much less affordable when interest rates are higher. General uncertainty about what direction the economy is heading in is also weighing on consumer sentiment, especially for big-ticket items.
Besides an acceleration of revenue growth, I also believe that for Tesla's stock to continue marching higher, the company will need to show some progress as it relates to profitability. And this area has taken a huge hit due to intense competition and ongoing price cuts to maintain market share.
During the third quarter, Tesla posted an operating margin of 7.6%, which was less than half the 17.2% reported in the year-ago period. Margins will really need to improve throughout the course of 2024 for the stock to do well. Based on recent history, it's not easy to be optimistic about this outcome.
One critical factor to keep in mind
But strong revenue and earnings growth likely still won't be enough to push Tesla's shares toward $500 in the next year. The missing piece of the puzzle is to consider what will happen with the valuation.
As of this writing, Tesla's stock trades at a steep price-to-earnings (P/E) ratio of 78. Some might think this is justified given the company's market share, disruptive and innovative potential, and industry-leading profitability.
However, it's worth pointing out that Tesla's stock has gained 98% this year mainly due to the fact that the P/E multiple rose by 105% during the same time. In other words, investors have grown more enthusiastic about the business over the course of 2023, which is reflected in the stock price. This could be viewed as a serious headwind for prospective shareholders looking for outsized returns going forward.
In my opinion, it's probably accurate not to assume that Tesla's valuation can keep rising over the next 12 months. Market sentiment is unpredictable, and for Tesla, expectations already seem to be sky high. And in an environment of higher interest rates and elevated inflation, fundamental performance really matters to shareholders.
Therefore, the company will need to post incredible financial results, particularly a doubling of earnings per share between 2023 and 2024, for the stock to hit $500 by the end of next year.
Due to recent trends, like a slowdown in revenue growth as well as compressing margins, I don't believe that this bullish scenario will happen. And for that reason, it's best if investors temper expectations they might have with Tesla.
