Simon Sinek is an inspirational speaker, and he is the author of the book Start With Why. In this article, I’ll examine Tesla (NASDAQ:TSLA) stock based on Sinek’s belief that ““people do not buy what you do, people buy why you do it.”
So why have Tesla’s shares soared in 2020? Did people buy the stock because they believed in the vision of the company? Or was its tremendous surge caused by speculation and momentum trading triggered by FOMO (fear of missing out)?
Start With Why
A key catalyst for TSLA stock was the decision, made in late November 2020, to include Tesla in the S&P 500, starting in late December.
The news sent the stock to a new 52-week high on the last trading session before the shares were added to the index. In 2020, Tesla’s stock has jumped by an impressive 690%. Huge purchases of Tesla’s shares by index funds that track the performance of the S&P 500 and by other institutional investors paid off well for the owners of the electric-vehicle stock.
But is the well-known investing advice “buy the rumor, sell the news” true for Tesla stock? It could be, because on its first trading day as a member of the S&P 500, the stock fell nearly 7%, and it is down nearly 5% from its 52-week high.
I strongly believe that, as a result of the inclusion of Tesla stock in the S&P 500, the shares are unlikely to generate irrationally high returns in the future.
The reason for that has to do with the institutional investors who bought the stock this year. Assuming that major index funds have already bought the number of Tesla’s shares they need to replicate Tesla’s weight on the S&P 500, there will be less demand for the stock’s shares.
In other words, after index funds buy enough of Tesla’s stock to ensure that it makes up the same percentage of the funds’ assets as the shares’ proportion of the S&P 500, the funds will wait until the price of Tesla’s stock falls before buying more of it.
Let’s Talk About Valuation
Is TSLA stock an automotive stock or a tech stock? I think it is an automotive stock, so its valuation should be compared to the metrics of the “Big Three” American automakers and to the S&P 500 index.
As of yesterday’s close, the average price-earnings ratio of the S&P 500 P/E ratio is 15.87, as the U.S. stock market seems to be overvalued.
Based on the performance of Tesla over the last 12 months, Tesla stock had a P/E ratio of 1,265.33. That valuation is irrational.
Tesla’s market capitalization is now higher than the combined market capitalizations of General Motors (NYSE:GM), Ford (NYSE:F), and Fiat Chrysler (NYSE:FCAU).
The trailing P/E ratio of the auto and truck manufacturing sector is 49.5, according to CSIMarket. If Tesla stock was trading at that P/E ratio, its stock price would be $25.72. And worth noting is that Fiat Chrysler’s trailing P/E ratio is below eight.
2020 Was a Game Changer for Tesla, But It’s Not Yet Consistent
To be included in the S&P 500, Tesla had to deliver four consecutive quarters of profitability. Showing that the company has had a successful year, Tesla managed to meet this criteria.
But what concerns me is that I do not yet see consistency in the company’s profitability and free cash flows. And I am not sure whether the company can meet analysts’ average annual EPS growth estimate of 32.9%.
Price Cuts Are Hurting Tesla’s Profitability
Tesla has implemented a few price cuts in 2020.
These price cuts have reduced the firm’s profitability, and they suggest that competition from other automakers has already hurt Tesla.
A New, Strong Competitor Could Appear Soon
Apple (NASDAQ:AAPL) reportedly “wants to release a self-driving, electric consumer car by 2024,” according to Reuters. Furthermore, “the tech giant would face competition from dozens of new electric vehicles that are set to flood the market over the next few years,” the news service stated.
I believer this article highlights the intense competition of the EV market now and in the future. That factor, along with the likely coming expiration of many governments’ subsidies for EVs, is negative for Tesla’s outlook.
Tesla’s Strategy Going Forward
Investors today seem not to care about the financial metrics of the companies in which they invest. As a result, many investors are buying TSLA stock because of the excitement surrounding the shares. But it does not make sense to ignore Tesla’s overdone valuation.
I expect Tesla to make some strategic acquisitions using its highly valued shares, leaving it well-prepared for the future and improving its position vis-a-vis its competitors.
But I wonder why Tesla has not yet implemented any stock buybacks and when it could launch such a strategy. Stock buybacks are a strong signal that companies believe their shares are undervalued.
The Bottom Line on TSLA Stock
Logic and fundamental analysis suggest that Tesla’s shares are significantly overvalued and that expectations for the company are too high. After its inclusion in the S&P 500, Tesla will transition, in the coming months and years, from a speculative growth stock to a more mature company.
On the date of publication, Stavros Georgiadis, CFA did not have (either directly or indirectly) any positions in the securities mentioned in this article.
