A few weeks ago, I set out to really delve into Tesla Motors (NASDAQ:TSLA) to decide whether it is worth my investment dollars.
Let's be clear upfront: Tesla makes some of the coolest cars around, at least in my opinion. CEO Elon Musk has turned the electric-car market upside down with the Model S, the soon to be released Model X, and the upcoming, potentially game-changing Model 3.
The Supercharger network and Gigafactory could also be game changers (and you can read more about them in an earlier article). But with all that said, if the valuation doesn't make sense, then what's in it for investors?
What's the potential?
Some investors are likely to find Tesla "un-investable," considering that it is not yet profitable on a generally accepted accounting principals basis, while trading with a market cap of almost $30 billion.
For perspective, Ford and General Motors trade with a market cap of $66 billion and $55 billion, respectively, while producing millions of vehicles per year. Tesla produced about 22,500 vehicles in 2013.
If the company's Gigafactory is successful and on time, it will produce enough batteries to supply 500,000 vehicles per year in 2020.
Let's assume that Tesla can produce that many vehicles per year. (Just hang with me for a second, because making estimates on cars that don't exist yet isn't exactly easy.) But here's a quick "estimation table" of what those sales could look like in 2020:
|Vehicle||Sales (units)||Average Selling Price||Total (in billions)|
The Model 3 has an estimated price of $35,000 -- at least, that's Musk's intention. The Model S starts at $69,900 and the Model X does not have a known price yet, but I used $75,000 as an estimated starting price for the Model X, though this may be conservative. I added a 15% premium to each model's starting price to account for upgrades and higher prices.
The result is $30.9 billion in sales for 2020, if there aren't any hangups in the Gigafactory and if it does indeed produce enough batteries for 500,000 vehicles per year. Of course, Tesla would need to sell 500,000 vehicles per year as well, not just produce them.
Anyway, that's one of the better-case scenarios for Tesla. The best case would have the same amount of unit sales, just with higher prices.
What is Tesla -- automaker or technology company?
This has drastic implications with regard to how one should value Tesla's stock. Is Tesla an automaker? Because if so, today's stock price may already be considered fully valued, even based on those tremendous sales estimates for 2020. Allow me to explain.
The automotive industry trades with an average PS ratio of 0.9. Meaning that if Tesla were to have about $31 billion in sales in 2020, a 0.9 PS ratio would indicate a market cap close to $27.8 billion.
However, if Tesla is considered a technology company, that sector trades with an average PS ratio of 3. In other words, its hypothetical $31 billion in sales for 2020 could justify a market cap of roughly $90 billion -- over three times today's valuation.
Truth be told, the answer likely lies somewhere in the middle, that is, between an automaker's valuation and a technology company's valuation. The midpoint, or just about 1.5 times sales, would roughly indicate a market of $60 billion.
Foolish final thoughts
The company has to continue improving margins, boosting sales and upping production. Supercharger stations must continue coming on line, and the Gigafactory can't have any major delays.
Aside from significantly boosting the scale of production, the Gigafactory will also significantly reduce input costs, perhaps by as much as 30%. A lot obviously hinges on the Gigafactory, and that's part of what makes Tesla such a gamble and hard to value.
Although the recent announcement of Panasonic joining in on the Gigafactory investment lifts some of the risk off Tesla.
Tesla makes amazing vehicles, and Musk has tremendous vision. Shares are what I would call "fully valued" at current levels for the next several years. This is because investors have already priced in so much good news and near-perfect execution. Looking into the future by five to 10 years, Tesla appears undervalued.
Of course, this all depends on the investor, too. Those invested in Tesla should be in the stock because they believe in the long-term, disruptive potential of the company, which comes with very high valuation metrics, as well as lots of volatility. So investors should consider these things when determining if the stock is a good fit for them and their tolerance for risk.
As electric vehicle driving ranges increase, batteries get cheaper, and performance gets better, more and more consumers likely will consider making the move to electric vehicles. For now, Tesla is at the forefront of that movement.