Tesla (TSLA -1.11%) stock has crushed the market so far this year. However, it's still down over 40% from its all-time high during a time when many other mega-cap growth stocks, like Microsoft, Apple, and Nvidia, are making new all-time highs.
Tesla has what it takes to continue its hot streak going into 2024. But it has to execute across some key aspects of its business. Here's what to watch next year and what the electric car stock needs to do to justify a higher valuation.
Image source: Getty Images.
Managing margins
In hindsight, it's easy to see why Tesla hit an all-time high in early 2022. The once-unprofitable company shocked the investing world with quarter after quarter of consistent profits paired with high revenue growth and high margins.
Tesla carried its torrid growth pace into 2022 -- posting a banner year across the board. But Tesla's margins have since come down, and its top- and bottom-line growth rates have slowed.
Over the last year, Tesla's trailing-12-month revenue has grown by only 17.8%, while its net income is down 14.3%, and its operating margin has fallen by over a third to 11.2%. The following chart does a good job of showing Tesla's massive growth, followed by this year's deceleration.
TSLA Operating Margin (TTM) data by YCharts
Price cuts and lower growth contributed to Tesla's margin decline this year. However, its margins could be lower in the future as Tesla tries to unlock entry into the coveted mass-market electric vehicle market, which would shift the company's strategy toward higher volume, lower-priced vehicles.
In its third-quarter earnings presentation, the company reiterated its goal of a 50% long-term production compound annual growth rate. It would be a worthy trade-off if Tesla achieves solid revenue and earnings growth at the expense of a lower margin.
In the short term, be on the lookout to see if Tesla can improve its operating margin. Longer-term, the challenge will be finding the sweet spot between revenue growth and profitability.
Monetizing AI and robotics
Tesla has done an impeccable job of becoming a profitable and (generally) high-growth electric vehicle company. But it has yet to monetize its artificial intelligence (AI) and robotics ventures -- mainly fully autonomous self-driving vehicles.
For several years now, Tesla has been flaunting its self-driving software. It got to the point where Tesla was thinking far too long-term and had to reel itself in and focus on generating positive cash flow from the Model 3 and then the Model Y. Thankfully, Tesla did that. But the company has a history of throwing money at projects that either pan out later than expected or don't pan out at all.
Tesla has an extremely attractive portfolio of AI and robotics ideas. Cracking the code on vehicles that can safely drive themselves would open the door to electric robotaxis -- an idea integral to the ultra-bullish investment thesis held by Cathie Wood and others.
While you could argue that Tesla could have made a lot more money if it hadn't spent so many resources on self-driving, the long-tail potential is too appealing to ignore. If you invest in Tesla, you have to accept that this will simply be a part of the company's budget and that it may not prove to be a worthwhile investment for some time.
Preserving the balance sheet
Tesla has done an excellent job of keeping debt off of its balance sheet and relying on cash flows to fund both short- and long-term investments. The company has $15.9 billion in cash and equivalents on its balance sheet and just $3.7 billion in long-term debt.
It is impressive that Tesla can keep a largely debt-free balance sheet despite being in the capital-intensive auto industry and supporting expensive long-term projects. One of the biggest things Tesla investors should watch in the coming years is how the quality of the balance sheet responds if there is a prolonged slowdown in demand or if Tesla tries to invest even during a downturn in the business cycle. In other words, what is the extent of the damage to the balance sheet if expenses stay the same or increase, but cash flows decline?
The stock market can be overly focused on the short term. If Tesla barrels ahead full throttle on its multidecade plans even as growth slows, its performance deteriorates, and its leverage increases, then the stock could sell off. Even if investing throughout the market cycle is the right long-term move, it's vital to recognize that the market may be unwilling to think so long-term during a broad sell-off.
Know what you're getting into before you invest
If you invest in Tesla, it's important to understand that the company will probably stick to its long-term plans even at the expense of its short-term performance and the wishes of Wall Street. This mindset is why Tesla stock can suffer steep sell-offs and meteoric gains. When the stars align, Tesla looks like it can do no wrong. But when Tesla stubbornly pursues its goals no matter the market cycle, it can look reckless and borderline irresponsible.
Tesla is one of those companies where understanding the long-term investment thesis and what can move the stock in the short term are equally important. That way, you aren't caught off guard if the stock moves to the upside or the downside.
If Tesla improves its top- and bottom-line growth rates, bolsters its margins, charts a path toward monetizing AI and robotics, and maintains or improves its rock-solid balance sheet, the stock could surpass a new all-time high in 2024. But there's also a good chance that Tesla needs more time to return to the growth that investors have come to expect.
In sum, Tesla has the makings of an excellent long-term investment and is certainly worth holding or even buying a small position in. But there's no rush to dive in headfirst and buy the stock hand over first at this time.
