Let’s talk about Tesla (NASDAQ: TSLA) stock. Consider a price-to-earnings ratio of nearly 200. Few companies around the world boast a valuation so eye-watering. One way of looking at that P/E ratio is that investors are paying almost $200 for every $1 of yearly profit.
Sounds ridiculous? It probably should. Such relatively low earnings mean the share price has a long way to fall. The other side to this equation is that earnings must grow massively to justify the price. Old-school value investors would likely roll their eyes at the ‘value’ on offer with Tesla stock.
But here’s the kicker. The above P/E ratio isn’t from today, it’s from a month ago. Since that time, the shares rocketed from $329 to a high of $459. Investors were looking at a cool 40% increase on their holding. A £10,000 stake turned into £13,951 inside a month.
Just what on earth is going on here? Could Tesla simply be a juggernaut that will keep on surging?
Pricey stuff
In my view, the lesson here is that growth stocks aren’t cheap. It’s rare to find a company with excellent growth prospects with a below average valuation. And the most exciting firms with the highest potential to grow sometimes come with really silly valuations.
History provides us with countless examples of this phenomenon. To take a recent instance, Nvidia was trading at eye-watering levels in 2023. The stock had surged as investors flooded in during the early days of ChatGPT. Many were calling a $300 share price insanely overvalued. We all know what happened next.
Nvidia shares grew sevenfold in a couple of years. The firm did a 10-to-one stock split (effectively dividing the share price by 10) as it was growing so large. And because hundreds of billions were spent buying its high-performance chips for AI, the P/E ratio caught up. It now trades at around 30 times forward earnings, not far off the S&P 500 average of 24.
Worth it?
Will something similar happen with Tesla stock? Let’s look at the evidence.
Tesla is targeting rapid growth. The $1trn pay package for CEO Elon Musk if the share price goes up eight times in value is proof enough of that. But what’s funny is that it’s not selling regular cars that could get it there.
The largest catalysts are in self-driving cars (and robotaxis), robotics and battery storage. Tesla is spending huge amounts on R&D and hoovering up some of the brightest talent in the world.
Will this company be at the forefront of a driverless tomorrow? Or will it pioneer replacing millions of workers with humanoid robots? Will it solve one of Net Zero’s thorniest issues – storing excess energy? If it does then that silly P/E ratio might look a lot less fanciful.
Risks remain with such pricey stocks. For this reason, I wouldn’t like most of my portfolio to be composed of similar companies. But given the opportunities Tesla has with its technology, I think it’s worth a closer look.
