"Simplicity is the ultimate sophistication." -- Leonardo da Vinci

While the renowned genius Leonardo da Vinci was an expert in many fields, his attitude toward simplicity reaches far outside the bounds of his time period and professions. When it comes to investing, simplicity is paramount, and is the ultimate sophistication. With this in mind, let us turn toward today's heated market debate starring Elon Musk's Tesla Motors (TSLA 3.88%) and see how Leonardo's wisdom can tell us exactly what the future holds.

Model S. Source: Tesla Motors press images.

The most simple and logical way I can think of to evaluate Tesla is to compute what return you'll receive if the company reaches its long-term goals. Elon Musk and Tesla spell these goals out very clearly in the company's proxy statement. The company goals set around Musk's compensation package are:

  • Successful completion of the Model X Engineering Prototype
  • Successful completion of the Model X Vehicle Prototype
  • Completion of the first Model X Production Vehicle
  • Successful completion of the Gen III Engineering Prototype
  • Successful completion of the Gen III Vehicle Prototype
  • Completion of the first Gen III Production Vehicle
  • Gross margin of 30% or more for four consecutive quarters
  • Aggregate vehicle production of 100,000 vehicles
  • Aggregate vehicle production of 200,000 vehicles
  • Aggregate vehicle production of 300,000 vehicles
  • Market capitalization of $43.2 billion

All of these need to be completed by Aug. 18, 2022, in order for Musk to receive his options grant. These goals are also largely where Wall Street has derived its current valuation for the company. The last goal is what we need to focus on and its primarily the base argument for many who invest in Tesla today. So for simplicity's sake, what return would you get if Tesla were to become a $43.2 billion company nine years from today?

Mathematics 101
If you invest in Tesla at today's market price of $17.49 billion dollars and Tesla reaches it's goals, you as an investor will receive on average a 10.57% annual return over the next nine years. This is a fact, the math does not lie. Sounds pretty good right, 10.57% per year would definitely be satisfactory for most, but that's where things get fuzzy. Investing is all about the relationship between risk and reward. So what else would give us, on average, before adjusting for inflation, a 10.57% yearly return? The S&P 500 will: From 1920 through 2012 its compound annual growth rate was 10.06% per year. 

Looking at Tesla's implied rate of return using the company's goals, it becomes quickly apparent the 10.57% isn't sufficient to outweigh the risk associated with investing in the possibility the company will achieve these ambitious goals. An investor in Tesla today is being rewarded with half a percent extra return over the S&P 500 index, yet takes on significantly more risk than investing in the index.  

It may be tempting to rationalize investing in Tesla today. Maybe it'll achieve those goals in under nine years. Maybe it'll exceed those goals. While these are perfectly valid questions, it's up to you as an investor to determine your rationale for investing in whatever company you choose. So just how big are Tesla's goals outlined above?

Looking at the goal of a $43.2 billion market cap, it would be equal to $32.2 billion today. To put that into perspective, if Tesla accomplishes that goal in nine years it would be 69% the size of today's BMW brand adjusted for inflation. That in itself goes to show how ambitious Tesla's management team is, which is amazing. If you don't dream big or have mighty aspirations, then phenomenal accomplishments will never come your way. What the company has thus far achieved is monumental and a true testament to the entrepreneurial spirit in America.

Stay focused
Tesla has accomplished amazing things, but always remember to weigh risk and reward when investing. Just how much risk are you taking on for a given amount of return? The mathematics proves that with Tesla, investors are taking on a lot of risk for an amount of reward they could get by investing in a low-risk index fund. My only words of caution are: Please weigh your risks and rewards, and always be careful about how much of your portfolio is allocated to one company's future.