In November 2021, Tesla (NASDAQ:TSLA) shares closed at a price of $409.97. Since then, they’re down 70% – and they’re falling further in pre-market trading today.
I think there’s a strong case for thinking that the shares are a bargain.
Investing
Investing in a business isn’t about betting on where its share price will go. Any stock might go up or down for any number of reasons.
This is as true of Tesla as it is of any other stock. The fact that the stock is down 70% from its high doesn’t mean it can’t fall further.
One reason Tesla shares have been falling recently is CEO Elon Musk selling the stock. But the investment proposition comes down to the business itself.
Investing in a company’s stock involves owning part of the underlying business. For an investor, the return comes from the cash the company produces for its shareholders.
Whether or not a company’s stock is a bargain therefore comes down to whether or not it will generate enough cash in the future to justify its current price. So what about Tesla?
Returns
First things first – how much cash does Tesla need to generate for its shares to be a worthwhile investment? For me, the answer is $13.65bn per year.
Right now, a UK 10-year government bond comes with a 3.66% yield. As a result, Tesla shares need to offer at least that over the next decade to be a bargain.
At the moment, Tesla has a market cap of just under $382bn. But there’s more to the stock than just its price tag.
The company has $8.9bn in debt and $17.6bn in cash on its balance sheet. That gives it a total enterprise value of around $373bn.
A 3.66% annual return on a $373bn outlay amounts to $13.65bn in free cash per year over the next decade. That’s what I think Tesla needs to produce for its stock to be a bargain right now.
If interest rates go higher (as I think they will) then the equation might change. But with bond yields where they are, that’s what I’m looking for from Tesla as a potential investor.
Tesla shares
Over the last 12 months, Tesla has generated $8.9bn in free cash. That’s some way short of the $13.65bn it needs to average to be a bargain for investors.
In order to average $13.65bn per year, the company needs to grow its free cash flow at around 10% per year. So can Tesla do it?
I think there’s reason to think that it can. The company has been growing its revenues at around 44% annually over the last five years.
On top of that, margins have been expanding. As a result, its free cash flow has been growing faster than its revenue.
The company just announced that its deliveries for Q4 2022 were below expectations. But they were still up 30%.
A stock to buy?
A recession is likely to challenge Tesla’s growth, but 10% per year doesn’t look overly demanding to me. As a result, I think the stock is a bargain compared to a government bond.
However, I think there are better opportunities for my portfolio at the moment. At today’s prices, I’m expecting better returns from Meta Platforms, Amazon.com, and Alphabet, so I’m buying these instead.
