Chinese authorities appear to be powerless to stem the bleeding in stocks, with the main Shanghai Composite Index down another 1.3% on Tuesday, while the technology-oriented Shenzhen Composite Index fell 5.3%, with losses relative to their June 12 highs now totaling 28% and 38%, respectively.
To relatively little fanfare, we are witnessing a savage bear market in the world's second largest equity market that has seen at least $3.2 trillion in market value evaporate, or twice the market value of India's entire stock market, according to Bloomberg. Still, this outcome was predictable -- periods of stock market euphoria do not end differently.
Investors in U.S. stocks look unconcerned, however, with the Dow Jones Industrial Average (INDEX: ^DJI) and the broader S&P 500 (INDEX: ^GSPC) down just 0.76% and 0.65%, respectively, at 12 p.m. EDT. The technology-heavy Nasdaq Composite was down 1.29%.
Tesla Motors: A paradoxical downgrade?
Shares of Tesla Motors Inc (NASDAQ:TSLA) were down 5.22% in midday trading following Deutsche Bank's downgrade from buy to hold in a client note published this morning. Despite the downgrade, Deutsche raised its 2020 earnings-per-share estimate 11% to $22.20 and upped its price target from $245 to $280, matching yesterday's closing price of $279.72 with terrific precision (not coincidentally, in my opinion). What is going on?
First, the bulk of the price target increase is due to the bump in the forward earnings estimate, which Deutsche attributes to a different growth opportunity from Tesla's flourishing Electric Vehicle franchise:
In late April, Tesla announced plans to leverage their scale and battery systems knowhow in Stationary Storage. This market is in its infancy (1.2 GWh added in the US in 2014). But we've become convinced that it will increase dramatically (14.3 GWh by 2020). The global opportunity is likely >2x this level [...] We further believe that no company is better positioned to take advantage of this development than Tesla.
The trouble is that, according to Deutsche, the market, in its wisdom, has factored this incremental business into the share price:
But at this point, Tesla's shares appear to already reflect this opportunity [...] based on our current valuation framework there is insufficient upside to support a continued Buy recommendation.
In other words, if the stock price is already in line with your valuation or price target, the stock market is properly valuing the company's prospects, and there is no opportunity to outperform by loading up on the shares, thereby justifying an unenthusiastic hold rating.
Tesla's valuation: Challenges and concerns
Assigning an intrinsic value to Tesla Motors is extremely tricky. Consider that Deutsche's valuation is based on an EPS estimate five years out (you can't do much with current earnings, which are negative). In that interval, it expects Tesla to reach nearly 500,000 vehicle sales annually -- nine times the number of Model S and X vehicles Tesla says it will deliver this year (55,000). Similarly, Deutsche is forecasting a more than tenfold increase in the U.S. stationary storage market. But these are both nascent, and the uncertainty that characterizes their growth paths is enormous.
Furthermore, trying to value Tesla on the basis of its standard peer group of North American automobiles is next to useless -- these are not good comparables, neither in terms of product positioning nor growth profile (although they do provide some insight into profitability for a mature auto manufacturer). Investors ought to look for better benchmarks among growth companies that have successfully upended traditional markets.
Tesla Motors CEO Elon Musk proposed one such benchmark back in February when he suggested Tesla's market value 10 years hence could match that of Apple Inc. (NASDAQ:AAPL), at around $700 billion. That's possible, I suppose, but advancing the most successful company in history as your standard ought to be taken with a mountain of salt.
Where does that leave investors?
With shares trading at 89 times on the basis of enterprise value to this year's EBITDA estimate (EBITDA, or earnings before interest, taxes, depreciation and amortization, is a measure of cash flow), it's difficult to argue that they are discounting anything other than an extremely rosy scenario for Tesla.
That scenario may come to pass, but it's no certainty. As such, buying Tesla shares at current prices "should be labeled speculation (which is neither illegal, immoral nor -- in our view -- financially fattening)" -- to borrow a quote from Warren Buffett's 1992 letter to Berkshire Hathaway (NYSE:BRK-B) shareholders.