The story at Tesla Inc (NASDAQ:TSLA) is one of the most interesting in the entire stock market. Led by CEO Elon Musk, Tesla is building an automaker essentially from scratch. (Not entirely from scratch: the company did buy its Fremont, California plant from a joint venture owned by General Motors Company (NYSE:GM) and Toyota Motor Corp (NYSE:TM).) It will take years, if not decades, for Tesla to achieve its ultimate goals. That timeline leads to a great deal of volatility and controversy in Tesla stock.
Indeed, there are few stocks more divisive in the entire market. Tesla bulls call Musk a visionary and look to a future revolutionized by Tesla’s electric vehicles and solar cells.
The bears likely choose different words to describe Musk, pointing to a nearly $50 billion market capitalization off negative free cash flow. After all, Tesla shipped just 25,000 cars in the first quarter, and yet shares of TSLA surpassed that of Ford Motor Company (NYSE:F)!
There’s truth to both arguments — something TSLA bulls and bears alike too often forget. Tesla has impressive potential — and a price to match. Considering that the story surrounding Tesla stock is going to take years to play out, investors on both sides need to be nimble, and need to be willing to change their views to match the facts on the ground.
Most of all, they need to be humble — because at some point, many currently ardent Tesla investors will be proven wrong. Very wrong. The only question at this point is who.
Tesla Stock Is Tough to Value
— Elon Musk (@elonmusk) April 3, 2017
“A stock price represents risk-adjusted future cash flows.” Musk is precisely right.
The argument about the valuation of TSLA stock is, in essence, an argument about what those future cash flows will be. And that’s a legitimate argument to have. We don’t know what Tesla’s future auto shipments will look like. Government policies worldwide will influence the adoption of Tesla’s solar roofs. Considering a February rollout, it’s not yet clear what consumers think of the product, or how durable those roof tiles will be under real-world conditions.
Where are steel prices going? What will U.S. wages look like in 2018? How about 2025? Each of these data points shapes an individual investor’s model of what the current price of Tesla stock should be. Even that model impacts itself. The faster Tesla turns profitable, the less Tesla needs to issue equity to fund the business, and the more of the company current shareholders will own.
There are myriad questions to be answered when estimating — emphasis on “estimating” — how much cash Tesla will generate in the future, and thus how much a share of Tesla is worth. Intelligent, rational investors can come up with very different end results.
It’s worth remembering that none — not a single one — of those investors will be right. Some will be closer than others, but we’re all just guessing. There are plenty of reasons why investors on both sides could be terribly, terribly wrong.
What TSLA Bulls Should Remember
First, $50 billion is a lot of money. It’s too simplistic to argue that Tesla stock shouldn’t be worth more than Ford stock simply because Ford makes many more automobiles, and unlike Tesla, is profitable. It’s far from guaranteed that TSLA will be more valuable than Ford a year from now — or ten years from now. Tesla has an amazing amount of potential — but it has as much risk as almost any stock in the market.
Second, Tesla doesn’t operate in a vacuum. Competition in electric vehicles will be intense. GM has its Bolt. Nissan Motor Co Ltd (ADR) (OTCMKTS:NSANY) will replace the Leaf. On the higher end, Tata Motors’ (NYSE:TTM) Jaguar, Audi (OTCMKTS:AUDVF), Porsche (OTCMKTS:POAHY) and Mercedes all are targeting the space over the next two to three years.
Right now, Tesla can hold its own, and it likely will be a fearsome competitor for some time. But the company also has benefited from largely having the middle- to upper-end of the EV market to itself. That will change.
Third, stuff happens. Amazon.com, Inc. (NASDAQ:AMZN) was a dot-com bust fifteen years ago. Apple Inc. (NASDAQ:AAPL) almost went bankrupt. GM did go bankrupt, and Ford almost followed. One single, even minor, recession changes the growth trajectory for Tesla stock. Consumers tend to focus less on the environment when they’re worried about their own pocketbooks.
And, by the way, Tesla’s CEO is also launching rockets into outer space and trying to create cyborgs. He might get tired at some point. In all seriousness, growth stories generally don’t go in a straight line. TSLA stock likely won’t be any different.
What Tesla Stock Bears Should Remember
Admit it — even if you hate Tesla stock, the cars are pretty cool. Reviews are generally positive, and there is some value in the Tesla brand. The valuation may be too high, but it’s hard to see Tesla meeting the fate of the Delorean.
Secondly, comparing Tesla stock to Ford stock ignores the fact that Tesla isn’t just a car company. Tesla even changed its name from “Tesla Motors” to reflect that fact. The acquisition of SolarCity and the larger ecosystem ambitions of the company matter to valuation, too. Tesla wants to be a transformative company, not just an automaker.
Most importantly, valuation alone is a dangerous reason to short a stock. TSLA bears may be proven right in the long run, but the rest of the market has to realize it for Tesla stock to decline. What comes in the meantime — a borrow fee, potential “short squeezes” — could be painful.
What All Investors Should Remember
Investing is hard work, but it should be fun at least sometimes. It’s just money, after all. Enjoy the ride! Don’t take Tesla — or any other stock — so seriously.
In the case of TSLA, in particular, don’t be afraid to change your mind. Because with 100% of the value of Tesla Inc coming from future activity, not current earnings, all of us right now are simply guessing the best we can.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.