Carmaker Tesla (NASDAQ: TSLA) has seen sales boom in recent years. Electric vehicle demand is set to keep rising, which could help that momentum continue. But Tesla stock has fallen just over 50% in the past year.
I can now buy two Tesla shares for the price of one a year ago. If things go right, that might turn out to be an attractive opportunity. But I do not plan to invest and in fact think Tesla stock could keep falling. Here is why.
Business and investment
Sometimes I become aware of a company because it keeps popping up in everyday life. More and more I see Teslas on the road. Electric vehicles are set to become more popular globally and Tesla has a strong position in that industry. So, does that make Tesla a good investment?
Not necessarily, for two reasons.
First, selling is only one part of business, recorded in what is known as the top line of company accounts. The other part is costs, reflected in the bottom line. Tesla is able to sell lots of vehicles, but can it make and sell them profitably? The evidence on this is mixed. Last year the company did more than a billion dollars in sales per week on average, which I think is impressive.
That led to $5.6bn in profits, which looks good to me. But Tesla has only been profitable for a couple of years, reflecting the high capital investment required in its industry. On top of that, government-backed incentives in some markets mean that last year’s profits may not give much indication of what to expect in future. Growing competition is also a risk to profit margins.
Even if Tesla does prove that it can be consistently profitable, that alone does not mean it would be a good investment for me. That is because of the concept of valuation.
How I value Tesla stock
My main concern with the idea of buying Tesla stock is not the business, but the valuation.
Right now, Tesla has a market capitalisation of $561bn. In other words, if I took out an interest-free loan today to buy the company and repaid it using earnings, it would take me a century! That presumes Tesla can maintain last year’s record earnings. Maybe it will do better in future – but it could perform worse.
In investing terms, that means the price-to-earnings ratio is in triple digits. Such a valuation still looks far too high to me. Regardless of how good a business Tesla may turn out to be – which is still a matter of widespread debate – it faces all manner of risks.
The capital expenditure costs to build new plants like its German factory are huge. A wide range of competitors are moving into its turf, from electric vehicle specialists like NIO to established automakers such as General Motors. If they take market share, Tesla sales could plateau then start to fall.
My move
I like the Tesla business but there is no way I think it is worth over half a trillion dollars.
That makes me feel that Tesla stock could keep on falling. Whether or not it does, the valuation is too rich for me. So I will not be buying any of the shares for my portfolio.
