According to ChatGPT, the intrinsic value of Tesla (NASDAQ:TSLA) shares right now is between $85 and $120. For context, the stock is currently trading at $429.
This was – apparently – based on a discounted cash flow (DCF) valuation based on the next 10 years. So is the AI view miles off the mark, or are Tesla shares grossly overvalued right now?
Discounted cash flows
From an investment perspective, the intrinsic value of a business comes down to three things. All of them have to do with the firm’s expected future cash flows.
The first is how much it can generate, the second is how soon it can to do this, and the third is the risk of it coming up short. And a DCF model converts these inputs into a present value.
Without going into detail, there are three main rules: more cash is better, cash sooner is better than cash later, risky returns are worth less than safe ones. Those are the key principles.
That’s the methodology ChatGPT used in its valuation – and I don’t think investors should have a problem with it. So the question is why did it reach a valuation so far below the current price?
Inputs
The theory might be sound, but the trouble with any calculation like this is that it depends on the accuracy of the inputs. How much is Tesla going to make, how soon, and how risky is it?
ChatGPT assumes the firm’s going to grow its free cash flows at 8% a year for the next 10 years, then 3% after that. And it thinks that 10% is the right rate to reflect the risk.
Based on the $6.9bn, the firm has produced in free cash over the last 12 months that does indeed produce an intrinsic value of between $85 and $120. So far, so good.
I also think 10% is a reasonable rate to reflect the associated risks. That leaves one assumption – the 8% growth over the next 10 years, followed by 3% after that.
Growth
My strong suspicion is that anyone buying Tesla shares will be outraged by the idea that the company is going to grow at 8%. And they might have a point.
Tesla’s looking to establish itself in some pretty big markets. The two attracting the most attention right now are autonomous vehicles and humanoid robots.
In both cases, there are big obstacles in the way. So future cash flows from these ventures should be treated as uncertain – though they are a key part of the CEO’s compensation plan.
Nonetheless, if Tesla gets anywhere near its ambitions in either industry, annual cash flows seemingly have to grow by more than 8%. And ChatGPT seems to almost entirely ignore this.
Valuing Tesla
Tesla isn’t an easy company to value because its largest income streams might be ones it hasn’t yet developed. And they’re arguably highly uncertain and unarguably years away.
Figuring out what inputs to use in a DCF model to reflect these is therefore tricky. And it’s absolutely the case that intelligent investors can have different ideas.
I’m not a buyer of Tesla shares at $429. But I think ChatGPT’s range of $85-$120 is the product of some estimates of future cash flows that are likely to be inaccurate!
