I expect demand for electric vehicles to increase strongly in the coming decade – and that could mean much higher sales volumes at automaker NIO (NYSE: NIO). Last year, it saw sales volumes more than doubling from the previous 12 months. Meanwhile, the NIO share price has been going in the opposite direction and plunged 62% in the past year.
But does that make it a bargain for my portfolio?
How to value companies
To answer that I need to decide how I value companies. Different investors use a variety of approaches, although a few are very common.
One way is to look at earnings and then use what is known as the price-to-earnings ratio, or P/E.
The problem is that such an approach does not work for NIO, as it had no earnings last year. In fact it made a loss. It was smaller than the year before, but at $630m it was still substantial. That lack of profitability is already a red flag for me because normally, I like to invest in businesses that have proven the profitability of their business models.
Growing company
However, in defence of NIO, it is still in a growing industry. As we have seen before with Tesla, building factories, setting up a distribution network and creating demand take a lot of money. Some things, like factories, require high capital expenditure upfront. Building a manufacturing plant might help the business for decades, but a lot of the costs come before even a single vehicle has rolled off the production line.
That is why some investors use the price-to-sales (P/S) ratio as a way of valuing early stage companies. With growing sales and a declining market capitalisation, the P/S is close to four (actually for convenience I am using revenues as a proxy for sales in this calculation, although some electric vehicles manufacturers generate a portion of their revenues from government grants, not sales). That is a lot cheaper than Tesla, where the equivalent ratio is over 10.
But just being cheaper on this metric than Tesla does not make NIO a bargain. Tesla may be overvalued itself. Additionally, Tesla has strengths NIO lacks: it is bigger, the brand is better established and it is profitable. As an investor, profitability matters to me a lot more than sales. Growing sales is relatively easy for many businesses: the real challenge is to grow them profitably.
I’m not buying
So using these two common valuation techniques does not help me see the NIO share price as a bargain. Meanwhile, the company continues to rack up large losses.
I think NIO could benefit from growing customer demand, as its surging sales suggest. I also reckon that, like Tesla, it may be able to turn large losses into a profit down the line. But for now there is not enough hard evidence of that happening to make me want to buy the shares. The current NIO share price may turn out to be a bargain with the benefit of hindsight, but I am not yet convinced that it is. I am therefore not investing in the firm for now.
