Can Tesla stock grow any more?

Christopher Ruane sees a trio of potential reasons Tesla stock could end up selling for a higher price than today. But is that enough for him to invest?

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This year, it will be 15 years since Tesla (NASDAQ: TSLA) listed on the stock exchange. During those years it seems as if there has been a never-ending battle between bears saying Tesla stock was surely headed for a fall and bulls who reckoned the long-term investment case was not fully reflected in the price.

As ever, that remains the case.

Tesla stock is up 808% in five years and 84% just since late October.

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But with a market capitalisation of $1.2trn and a price-to-earnings (P/E) ratio of 108, Tesla’s current valuation seems to factor in a huge amount of growth potential – and even then could still be seen as pricy.

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I like the company’s prospects and think its strong brand, proprietary technology, and large customer base set it up well for ongoing commercial success.

But is there any point in me shelling out for Tesla stock at this point given its giddy valuation?

Three possible drivers for a higher valuation

That depends on what I expect to happen to the business in coming years and decades.

I do see several possible drivers to push Tesla stock even higher.

One, which we have seen many times in the past (just look at that gain since October!), is momentum. Stock market participants scared of missing out have often piled into Tesla shares, pushing the price up higher.

But that momentum-based approach does not interest me, as I think it is closer to speculation than investing. I prefer to invest in an enterprise (or not) based on business fundamentals.

Transformational business potential

Could the fundamentals justify a higher price?

Again, I think the answer is potentially yes.

One driver could be much improved earnings. Although the company’s electric sales volumes fell slightly last year, it has a long history of revenue growth and I think it has the tools to keep delivering on that, for example, by introducing new models.

Plus, in carmaking, economies of scale are a big thing (no pun intended).

Tesla’s strong sales mean it could improve profit margins in coming years, by stripping out costs and also selling add-ons with high profit margins. One risk I see there, though, is that the competitive electric vehicle market could mean it increasingly needs to compete on price, hurting margins.

A third driver is growth outside the vehicle business.

Its energy storage business is already going gangbusters. On top of that, Tesla could also launch new product lines from a driverless taxi operation to commercial applications using its vast trove of customer journey data.

If growth from areas beyond vehicle sales boosts earnings, that could propel Tesla stock upwards.

At 108, the P/E ratio tells its own tale

But a lot of that feels fairly speculative for now.

Meanwhile, Tesla’s triple-digit P/E ratio looks far too high for my comfort as a would-be investor.

Given risks ranging from growing competition to a change in tax credit regimes in the US and elsewhere, does Tesla stock merit being priced at over a century’s worth of earnings at the current level?

I do not think so.

Again, that feels like a speculator’s valuation to me, more than a savvy investor’s one. So, I have no plans to buy Tesla for my portfolio.

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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 and Uber Technologies. 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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