Last week, ARK Invest’s founder Cathie Wood announced a $3,000 target price on Tesla (NASDAQ:TSLA) stock. Shares of the electric vehicle (EV) maker bounced almost 8% on the news, adding $50 billion to its already burgeoning market capitalization.
There’s one small issue: That would make TSLA worth more than Apple (NASDAQ:AAPL) and Facebook (NASDAQ:FB) combined. Ms. Wood’s upper range — $4,000 by 2025 — would mean the EV maker could also swallow Google parent Alphabet (NASDAQ:GOOG,NASDAQ:GOOGL) for dessert.
It’s certainly possible that Tesla will achieve that and more; the electric vehicle company has proved that carmakers can earn 25% gross margins at scale. And, from self-driving taxies to space travel, there’s little stopping Tesla from making money from future ventures; a subscription to drive your car might be next.
But Tesla is already a massive company that will find it increasingly hard to become an even bigger one. The lofty price target will only earn investors an annualized 35% return.
So, go ahead. Buy some TSLA stock if you want. But make sure you leave room for the investments that sit beyond the reach of Wall Street’s elite.
TSLA Stock: In the News, But Not Newsworthy
By Wall Street’s standards, Tesla and Cathie Wood’s ARK Innovation Funds (NYSEARCA:ARKK) are both financial behemoths. Their massive size means that tiny price changes can make the equivalent of a JetBlue Airways (NASDAQ:JBLU) (market cap: $6 billion) appear and disappear in the blink of an eye. These companies have also made their bosses wealthy beyond imagination.
But there’s also a flip side to such success. Eventually, these firms’ sizes also acts as a hindrance — an anchor that puts a drag on performance. Good investment ideas dry up. Markets get saturated with products. No matter how tall these Wall Street and Silicon Valley superstars want to build their Tower of Babel, they’ll one day run out of bricks in the world to go any higher.
How Big Is Too Big?
So, how high can this tower go? On the corporate side, firms seem to reach this upper limit somewhere in the $1 trillion to $2 trillion market cap range. John Rockefeller’s Standard Oil managed a $1 trillion market value (in today’s dollars) before getting broken up by trustbusters in 1911. Meanwhile, Apple and Google — worth between $1.4 trillion and $2 trillion today — are seeing growth naturally slow even as they try their hand at new businesses.
Companies can shoot higher — the Dutch East India Company grew to an $8.3 trillion value in 1637 (adjusted for inflation) through government and military decree. But it’s an uphill battle to gain such heft, and these firms usually need to become state-sponsored monopolies to maintain their dominance. Tesla’s $4,000 price target puts it at about half of the Dutch East India Company’s size.
On the fund side, star exchange-traded fund (ETF) and mutual fund managers usually reach their size limits at a far lower scale: somewhere in the $10 billion to $50 billion range. That’s because most ETFs and mutual funds are limited in how much they can buy in a single company. Securities and Exchange Commission (SEC) rules restrict funds to 15% illiquid assets, which includes any large positions that can’t get sold within seven trading days.
There are also mathematical limitations. Even if Ms. Wood’s fund wanted to buy more shares in Organovo Holdings (NASDAQ:ONVO), a $70 million company owned by her flagship fund, it’s practically impossible for the $17 billion ARKK fund to hold a meaningful stake.
On the other hand, smaller funds and individuals can dance around the big players like David circling Goliath. By investing in their best ideas with little regard to market sizing, these investors can profit from unusual market opportunities. That’s why boutique fund managers tend to generate an average of 16% greater wealth compared to regular funds.
TSLA Stock, the Goliath
Ms. Wood doesn’t just want TSLA to go to $3,000. She needs it to happen. There are preciously few mega-cap tech disruptors in existence, and Tesla is one of the few remaining ideas that can meaningfully move ARKK’s needle.
Meanwhile, the far nimbler Direxion Moonshot Innovators ETF (NYSEARCA:MOON) has no such concerns. The $312 million fund’s average holding only has a $2.6 billion market cap, much smaller than ARKK’s $38 billion average. (MOON is also up 21% since January compared to ARKK’s -10.5% loss).
Individual investors have even better choices. A $5,000 investment in Takung Art (NYSEAMERICAN:TKAT) — a micro-cap NFT (non-fungible token) marketplace — would have transformed into $250,000 in less than three months. Baskets of small-cap value stocks are also up around 30%.
Conservative investors don’t have to miss out either. Thanks to industry consolidation and mandated pricing floors, high-earning railroads like CSX (NASDAQ:CSX) and Norfolk Southern (NYSE:NSC) are up over 220% in the past five years. Without impatient shareholders breathing down their necks, buy-and-hold investors can afford to wait for megatrends to play out.
A Cautionary Tale from the 1950s
Wall Street has a long history of trying to dazzle investors with hot mega-cap funds and firms. Perhaps the best example comes from Gerald Tsai Jr., one of the original celebrity fund managers of the modern investing world. In 1958, the Fidelity fund manager became a household name for his outsized bets on hot names like Xerox (NYSE:XRX) and Polaroid.
“Nobody had ever run a fund like that before,” reported the New York Times. “And the press, in particular, portrayed him as an investing genius.”
But as his fund grew, so did Mr. Tsai’s risk-taking. And when things started to unravel, it didn’t take much time for everything to fall apart. By 1968, his flagship Manhattan Fund was the sixth-worst performing fund in the country. The fund would ultimately lose 90% of its value and get bought for its $70 million of tax losses.
Today, Cathie Wood’s portfolio remains a world apart from Mr. Tsai’s Manhattan fund. ARKK looks in complete control with world-beating holdings like Tesla, Teladoc (NYSE:TDOC) and Square (NYSE:SQ). Its analysts are still the same brilliant folks that almost tripled the NASDAQ index return last year. But the fund’s returns are already slowing down as its asset size grows. Since January, ARKK has underperformed by 10.5%, and more pain could be on the way.
Yet, Wall Street and popular media continue drawing halos around these financial superstars. Perhaps it’s interesting to ogle at massive personal wealth. Or that these funds are so significant that they create a gravitational media pull.
Regardless, regular investors can safely ignore such chatter. Because when your financial career involves publishing a $3,000 Tesla target price, that’s not an investment strategy. It’s a marketing one aimed at those who remain forever enthralled by the fortunes of Wall Street’s elite.
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.