Is there any growth potential left in Tesla stock?

Tesla stock has shot up 85% in less than three months. Christopher Ruane shares his take on the firm’s valuation — and whether he’s buying.

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Owning shares in Tesla (NASDAQ: TSLA) has been a veritable goldmine for some investors. If I had bought Tesla stock at the right point in October, for example, I would now be showing a paper gain of 85% — in under three months.

I am a long-term investor though. But here too I could have done well. Very well, in fact. Over the past five years, the Tesla price has soared 1,085%.

Unfortunately, I did not hold Tesla during that period. So should I buy now — or has the investment case run out of growth potential?

The business environment has changed a lot

Last year saw Tesla’s annual number of vehicle sales fall, for the first time.

Now, to keep things in perspective, the drop was small. Tesla is still shifting tens of thousands of vehicles each week.

Nonetheless, a reversal in sales growth can be a sign that a company is moving from one stage of development to another, where the focus is less on growing sales volumes and more on increasing profitability, for example by raising prices and cutting costs.

But here I see some real risks for Tesla. The weaker sales last year were not because electric vehicles are declining in popularity. The total market size is growing – and I expect it to keep moving up.

Rather, Tesla is in a much more competitive market now than it was a few years ago, as multiple rivals have built scale to threaten its leading position.

That could lead to more price competition, hurting Tesla’s profit margins. On top of that, changes in tax credits in key markets could also eat into the US giant’s earnings.

Lots to love about the firm

Still, while any savvy investor takes a clear-eyed view of potential risks, Tesla is not exactly in a bad spot.

The vehicle business is substantial and the company has proved it has what it takes to succeed in it. Even before potential game-changers like self-driving taxi fleets, Tesla has carved out a strong and defensible niche for itself thanks to its innovative technology and well-known brand.

On top of that, the company is not a one-trick pony. It has a large and fast-growing energy storage business.

This strikes me as a smart way to capitalise on some of the expertise it is developing in its electric vehicle business. Over time, I expect energy storage to become a much more important part of the Tesla investment case.

The share price looks overvalued to me

On balance then, I think there could well be growth left in the Tesla business.

But what about the stock price?

The firm already commands a price-to-earnings ratio of 110. In other words, if someone bought the firm at its current valuation, it would take over a century’s worth of earnings at today’s level to pay back the cost of that acquisition, even before interest.

That looks heavily overvalued to me, even allowing for Tesla’s growth prospects, so I have no plans to buy.

Market momentum could yet drive the Tesla price higher. But based on business fundamentals, I see no rational reason for any such increase at this time.

By contrast, a sharp fall would strike me as more understandable in bringing the valuation closer to what I see as justifiable.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

C Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Tesla. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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