Tesla reports its earnings after the market close on Oct. 23. Tesla (NASDAQ:TSLA) stock will jump based on whether it meets analysts’ expectations. This is usually based on metrics like deliveries, profitability or projected production.
But Tesla is in the electric vehicle market for the long haul. Its plans really don’t depend on what the market thinks anymore. Investors should probably align themselves with that thinking.
Valuation Considerations for Tesla Stock
Investors need to take the long-term route on Tesla stock. There are a number of considerations that help with this.
For one, Tesla is now free cash flow-positive. In Q2, it reported $614 million in free cash flow. A big reason for this was the decrease in selling, general and administrative costs. That is a great accomplishment. For example, SG&A fell from $703 million in Q1 to $647 million in Q2, even though sales rose 47%. Moreover, analysts expect free cash flow will continue to grow each quarter.
Second, Tesla just received approval to produce cars in China with its new factory. This will allow Tesla to sell cars in China, the largest EV market in the world, without any tariffs. More importantly, all the capex for the factory has already flowed through its cash flow statements. In addition, capex going forward will be steady, at least until the next factory gets built.
Third, projections show that Tesla’s gross and net margins will grow with Tesla’s increasing production. And don’t forget it’s not really a question of demand. The issue is how fast can the company ramp production at profitable rates. One analyst predicts $4.1 billion in profitability in 2020, $7.7 billion in 2021 and $12.5 billion by 2022:
TSLA Stock Valuation and the Long-Term Investor Mindset
Tesla stock has a market value right now of $46 billion. So, if the predictions above come true, TSLA stock will have low valuation metrics. For example, it will have a forward P/E ratio of just 11.2x for 2020, 6x for 2021 and just 3.7x for 2022.
So, if these predictions have a good chance of coming true, quarterly misses don’t matter. That is what a long-term investor thinks. And some very smart people agree with this approach to investing.
Several authors in Harvard Business Review (HBR) have pointed out that this kind of thinking pays off. In the Feb. 7, 2017 publication of HBR, Dominic Bartin, James Manyika, and Sarah Keohane Williamson wrote an article about this. It was titled: “Finally, Evidence That Managing for the Long Term Pays Off.” They wrote:
“Companies deliver superior results when executives manage for long-term value creation and resist pressure from analysts and investors to focus excessively on meeting Wall Street’s quarterly earnings predictions.”
Dominic Barton and Mark Wiseman, in the January-February issue of Harvard Business Review, had similar views. They argue that companies that focus on “short-termism” are:
“… less able to invest and build value for the long term, undermining broad economic growth, and lowering returns on investment for savers.”
Their article, “Focusing Capital on the Long Term,” urged the U.S. and other economies to move away from “quarterly capitalism” to “sustainable capitalism.”
Tesla Is Taking a Long-Term Approach
This is exactly what Tesla is doing. They are investing for the long-term. Elon Musk, CEO of Tesla, wrote a section in the quarterly letter in the section titled “Outlook” that resonates with this approach:
“This quarter, we are simplifying our approach to guidance. We are most focused on expanding our manufacturing footprint in new regions, launching new products, and continuing to improve the customer experience, while generating and using cash sustainably.”
So, investors in Tesla stock should take the same posture: take the long-term investment view.
What This Means for Quarterly Earnings Updates
Here is what typically happens. A stock meets or beats analysts’ expectations. The stock jumps up or down based on preconceived notions. The short-term hurdles are set up by Wall Street analysts and TV commentators.
Long-term investors really don’t care about those things. For example, as a Chartered Financial Analyst charterholder (CFA) I always wait until quarterly filings before analyzing a stock. I also wait until Wall Street analysts have made their comments.
Moreover, I almost always ignore these analysts. Typically they are addicted to pronouncing whether or not a company meets their quarterly expectations. Instead, I look at the longer-term projections and past history. I try to decide whether the stock is still offering a valuable upside.
I believe that Tesla stock offers huge upside for long term investors. Tesla is a cash flow profitable company in a new and fast-growing industry. Tesla stock trades at between 4 and 6x earnings two or three years in the future. That is a long term bargain.
As of this writing, Mark Hake, CFA, does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here. The Guide focuses on high total yield value stocks. These are stock with high yields and buyback programs. Subscribers receive a two-week free trial period.