On Thursday, shares of Chinese electric vehicle (EV) makers Nio (NYSE:NIO), XPeng (NYSE:XPEV) and Li Auto (NASDAQ:LI) each slid 10% to 15%, wiping out a collective $10 billion of investor savings. Even Tesla (NASDAQ:TSLA) stumbled 6%. Meanwhile, trading volumes remained flat across EV stocks, suggesting people weren’t interested in buying the dip.
Much of the fall seems like an overdue correction. EV cynics have long pooh-poohed the idea that an industry that produces just 600,000 cars annually should be worth almost $1 trillion. Indeed, no single news piece seemed responsible for the electric vehicle stock rout. (Though worries of an ADR stock ban hit Chinese carmakers harder).
But regular investors deserve more than the “I told you so” treatment. Instead, here’s a game plan: add selectively during this pullback, but keep a lot of dry powder if things go further south. There are good reasons why everyone else isn’t jumping in headfirst.
The EV Market: How to Value Giants
Firstly, the good news: traditional financial metrics grossly undervalue Tesla and Nio.
Electric vehicle naysayers love comparing Tesla and Nio’s outsized market cap to those of legacy automakers. They will quickly point out that Nio stock is worth more than Honda (NYSE:HMC), a profitable automaker that produces 100 times more vehicles. Meanwhile, Tesla is worth all Western carmakers combined.
These generalizations, however, miss a bigger truth: electric vehicle makers are far more lucrative than their legacy competitors. Tesla generates 25% gross margins – double the margins of Ford (NYSE:F) and other Detroit automakers. Even Nio has shown an uncanny ability to make money, despite its relatively small size.
Any EV fan can tell you why. Not only do these luxury car makers pack their vehicles full of pricey features. Their direct-to-consumer model means the extra profits flow straight to the carmakers rather than to dealerships. Government tax credits also help, at least in the short term; Telsa has earned more from clean energy tax credits than selling vehicles.
The extra profits mean fat valuations. The typical automaker earns 2% net margins in good years. Bumping that figure to 15% (assuming gross margins filter down to the bottom line) means that the electric vehicle industry could become worth 7.5 times more than their $1.3 trillion legacy cousin one day. (That also assumes no change in P/E ratios). It’s the lens that Cathie Wood’s ARK Innovation Fund (NYSEARCA:ARKK) used to set a $3,000 target price on TSLA stock.
What are Tesla and Nio Stock Worth?
Then there’s the bad news: legacy makers like Volkswagen (OTCMKTS:VWAGY) and Ford are starting to get in on the fun.
In early-March, Volkswagen announced significant plans to enter the electric vehicle space. Shares of the newer EV makers went into a tailspin; VW’s higher-end brands – Audi and Project Trinity in particular – pose a very real threat.
That’s because car brands have always suffered from relatively weak network effects. The Tesla in your neighbor’s garage doesn’t add much to the one in yours. Industry players – from service stations to lidar manufacturers – have also long worked to disarm carmaker monopolies. Few automakers ever exceed >30% dominance in any single market.
Considering these facts alone, Tesla’s auto business might be worth around $300 billion, or $300/share. (That’s before you include value-added products like self-driving taxis, media and subscriptions). Nio’s business, meanwhile, could be worth as much as $50/share thanks to its smaller starting market cap.
Lessons From Apple
Still, there’s some reason for investors to buy the dip cautiously.
Few price EV makers on car sales alone. Just as Apple (NASDAQ:AAPL) upended the cell-phone world by selling high-margin products with even higher-margin software, firms like Tesla and Nio are rethinking what it means to own a car.
Today, Tesla’s self-driving car dreams look much like Apple’s initial forays into apps and media. It’s the only way the handset maker manages to generate almost 40% gross margins, or twice as high as peers. Nio has even gone to create “Nio Houses” – dedicated clubs for its car buyers to congregate and relax.
Adding in these value-added services puts Tesla’s value anywhere from Morgan Stanley analyst Adam Jonas’s 2022 target of $880 to Cathie Wood’s $3,500 price by 2025. Nio’s upside could be even higher if the firm manages to dominate its markets one day.
Where Will Nio and Other EVs Go?
Investors need to play Nio and Tesla’s dip carefully. The go-go days of 2020 are quickly fading as EV investors reconsider the limitations of innovation. Even firms like Apple aren’t immune to competition. Though their iMac computers consistently earn rave reviews, Apple’s desktop products run into heavy competition from lower-cost manufacturers. It’s hard to compete against a $799 all-in-one HP desktop that essentially earns zero margins.
Today, Nio and other electric vehicle startups face the same reality that legacy automakers also want a piece of the pie. And they won’t go down without a fight.
So, move forward with caution. Tesla at $600 and Nio at $35 might be worth buying some amount. But make sure you have enough spare change in case prices fall even further.
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.