Trying to understand why a stock's price moves up or down on any given day is a fool's errand. Sure, sometimes large pullbacks or gains in a stock's valuation are justified, but on the vast majority of days, a stock's price follows little rhyme or reason.
That statement is especially true for growth stocks that often find themselves on a roller-coaster ride, such as Tesla Motors (NASDAQ:TSLA). Tesla stock was trading down roughly 10% Monday, and here are a couple of things to consider about its movement.
Valuation vs. business
Investing in the stock market can be tricky, that much is clear. Keep things simple: If you find businesses that you believe in, ones that solve problems and create value, oftentimes you'll find market-beating gains. However, Tesla's valuation has risen so far, and so fast, over the past two years that it's difficult to say its current price is warranted despite its clear potential to disrupt the automotive industry in a way we haven't witnessed in nearly a century.
Things to consider
While investors buying into Tesla realize this is a long-term investment, and not one for the faint of heart, there are a few things to consider.
First, drops like yesterday will happen frequently with such a lofty valuation and uncertain future. Tesla's market capitalization of roughly $32 billion is right at half of Ford Motor Company's $64 billion valuation. Let's think about that another way. Tesla is being valued at half of Ford's value despite the latter producing $8.6 billion in pre-tax profits last year while selling more than 6.3 million vehicles globally; meanwhile, Tesla has yet to produce a GAAP profit and, in a perfect world, will sell less than one-tenth of Ford's 6.3 million vehicles annually by 2020.
Don't get me wrong, these two companies are far from a perfect comparison, but even Tesla CEO Elon Musk has a difficult time grasping investors' valuation of his company.
"I think our stock price is kind of high right now," Musk said, replying to a question posed by CNBC at a news conference earlier this month. "If you care about the long term, Tesla, I think the stock is a good price. If you look at the short term, it is less clear."
In fact, Musk made similar comments almost a year ago, when Tesla's valuation was less than half of what it is now. In my opinion, his comments alone are reason enough for a 5% to 10% drop in Tesla's stock price.
Also worth noting is that Morgan Stanley analyst Adam Jonas recently released a note to investors highlighting several factors that could weigh on the stock price in the near term, including slower-than-anticipated growth in China and the fact that the Gigafactory might not cut battery costs as much as predicted. It should also be noted, though, that despite Jonas' reservations, he also remains a long-term Tesla bull with a price target of $320.
Another factor often forgotten with long-term investors is Tesla's ongoing battle with dealerships and legislation banning the automaker from selling its electric vehicles directly to consumers. Currently, Tesla's state-by-state battle is a complete non-factor, as the company remains supply-limited, and consumers who really want to get their hands on a Tesla will find a way to do so. However, as Tesla inches closer to mass-adoption with its electric vehicles over the long term, expect these battles to become much more detrimental to the company's potential, and stock price fluctuations.
Investors also have to consider the sizable risk of something going wrong on the path to Tesla's mass-market adoption of electric vehicles. Every company will hit speed bumps and Tesla will certainly have growing pains, despite the company holding true on just about every promise it's made thus far. It's likely that Tesla will face one or even two recessions before it achieves mass-adoption of electric vehicles. Even a slowdown in the overall automotive industry without a recession could seriously dent its valuation -- a move that would surely make today's 10% drop look like a thing of beauty.
On the bright side
Despite this pullback, one that's warranted in my opinion, Tesla's stock price has surged nearly 70% this year and investors in this company will have to consistently keep the big picture in mind. These substantial swings will be common in the decade ahead as investors, analysts, and the company itself struggle to identify just how lucrative its future potential really is.
Tesla is in the very early chapters of a long story, and there are plenty of positive catalysts ahead; including getting its Gigafactory churning out batteries by the hundreds of thousands -- even if it doesn't cut costs as much as expected -- and its all-new Model X hitting the streets soon.
Tesla also has incredible potential in China, even though progress is slower than anticipated, to help solve an ever-growing pollution problem as the government hopes to spur sales of electric vehicles in its megacities. Tesla's automotive gross margin of nearly 27% on a GAAP basis also gives investors real hope for juicier profits in the future, compared to typical automakers', once the electric automaker has accelerated production and sales growth.
Tesla's valuation is sky high, and so is its potential to disrupt the automotive industry and spur the mass adoption of electric vehicles across the world. If you found yourself Googling "Why Is Tesla Stock down today?" yesterday morning, I'd kindly suggest that you don't do that again for the next 10 years. In a decade, you'll have saved yourself a lot of sleepless nights and will still likely have been rewarded for your patience -- and you'll still own part of a company with enormous potential to dream about, instead.
Daniel Miller owns shares of Ford. The Motley Fool recommends and owns shares of Ford and Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.