TM - Is Tesla Stock Still A Good Investment? 3 Questions You Need To Ask

2023-10-17 09:44:16 ET

Summary

• Tesla, Inc. trades for roughly 74x earnings while its closest competitors trade for 5-10x.
• Is Tesla stock too expensive, its peers too cheap, both, or neither?
• The overall car sales market is facing challenges due to decreased obsolescence and demographic changes, potentially impacting the future profitability of automakers.
• The EV market is growing, but recent data shows Tesla's market share is starting to slip.
• Three questions investors in Tesla shares should be asking.

The electric vehicle ("EV") transition is for real and is happening at a steady pace, although perhaps at a pace a bit slower than automakers had hoped. J.D. Power data shows that 8.6% of cars sold in the U.S. in Q3 were electric, with big gains also for hybrids and plug-in hybrids. Tesla, Inc. (TSLA) remains the clear market leader but is losing a bit of market share despite price cuts.

If you're reading Tesla articles on Seeking Alpha, you likely already know all of this. Tesla stock has had a wild ride over the past few years, and the natural question is whether it can sustain itself. In my mind, there are 3 questions that you have to ask to answer this: the first being the business valuation; the second being the overall economy/demographics; and the third being whether Tesla's competition is catching up.

1. Tesla's Valuation Has Changed Significantly Since 2019: Is Buying Tesla Stock Like Betting On Ohio State -49.5?

College football and the auto industry have something in common, which is that it's easy to know who the strong teams are. However, when putting money to work in stocks, long-term investors also have to consider the valuation of the underlying business and whether they'll see a return on their money from cash flow. History clearly shows buying a good business for close to 100x earnings is often worse than buying a decent business for 5x earnings. In this same vein, if you bet on Ohio State -49.5 against some random nonconference opponent, they're likely going to win the game. But oftentimes they're not going to win by the 7+ touchdowns necessary for you to make any money. The bookies know this, and Wall Street does too.

Here's an interesting stat for you guys - Tesla trades for roughly 74x current year earnings. General Motors ( GM ) trades for 4x earnings. Ford ( F ) trades for 5.8x earnings . Volkswagen trades for a P/E ratio of roughly 4x . Toyota ( TM ) trades for 9.5x earnings . China's BYD Company Limited (BYDDF) is the only company that really approaches Tesla's level of valuation, trading for roughly 19x earnings . The question you should ask yourself is, does this make any sense? These levels of earnings could theoretically support dividend yields in the 10-20% range (maybe not as a regular dividend, but certainly as a special). These could be value traps, but it's worth exercising your brain to figure out why or why not.

From a business perspective and ignoring the valuations, you'd definitely rather own Tesla. For one, the Detroit automakers' earnings are likely to come down as a result of the UAW strikes. They're saddled with huge levels of fixed costs that their competitors with production in China, Central Europe, and Mexico don't have. The unions are looking to claw back a lot of the excess profits that the Big 3 automakers have been making in recent years, which may mean that instead of trading for 4x earnings, they might be trading for 7x or 10x once the unions renegotiate their pay. Of course, you also have UAW President Shawn Fain wearing an " Eat The Rich " t-shirt and throwing management proposals in the trash on livestream. Tesla doesn't have to deal with this, they're now based in Austin, Texas and their employees are not unionized .

We know Tesla is a better business than the Detroit automakers and probably better than most of the imports as well. What's much less clear is whether it's 10x better in terms of valuation. Many investors are taking this on faith at this point, but keep in mind that Tesla stock went nowhere from late 2013 to early 2019, then exploded in value. Tesla's business has been admirable, but the explosion in the stock price is extremely recent and has been tied to the S&P 500 (SP500) index inclusion. Since TSLA was added to the S&P 500 in late 202, the stock is relatively flat. This is not surprising, since the S&P 500 index money was part of the fuel that caused Tesla stock to rise so much in 2020.

My point here is that the huge multiple for Tesla stock is a relatively new phenomenon that coincided with the pandemic "everything bubble," and index funds being forced to buy billions upon billions of dollars in stock. The overall valuation for Tesla has changed dramatically in the recent past, and that will make it much harder for investors going forward to make money buying TSLA stock. It's not enough to say that the Ohio State Buckeyes are unstoppable and put your money behind them at any price. You have to consider how the market is valuing them and adjust accordingly.

For example, take a look here at Tesla's stock price compared to its earnings.

Investors took Tesla on faith during the 2010s. Tesla lost a little money but was able to raise plenty more by selling stock and issuing debt in a zero-interest rate environment. Now Tesla has become what its fans had hoped it to be.

However, we see earnings leveling off with interest rates rising, while the P/E ratio remains very high. At the same time, we see analyst earnings estimates being revised downward amidst this year's price war. Either Tesla's business will need to take off, or the stock price is likely to fall back towards where it was when it started the year. I think there's a rebuttable presumption that Tesla stock entered a bubble in 2019 and is now trying to fall to its fair value through fits and starts.

2. Are Overall Car Sales In The U.S. And Europe Sustainable?

Another interesting thing about the car industry for me is the idea of obsolescence - or lack thereof. We know that Americans are keeping their cars for longer and longer amounts of time. This is really interesting- the average car in 2003 was about 9.7 years old, and now the average car is 12.5 years old . The trend shows no sign of reversing and is mirrored in Europe as well.

Think about the demographics here. Historically, auto sales in the U.S. have been driven by two factors, which are demographic growth and obsolescence. Globalization has forced automakers to build cars that last longer, and an aging and possibly shrinking population won't need or be able to buy as many cars. As you can see here, there's some pent-up demand from the pandemic supply chain chaos (which appears to have peaked earlier this year). However, overall auto sales have gone nowhere in 20 years, and demographically have reasons to go even lower.

Building cars that only last for a few years before breaking was never sustainable with global competition. People tolerate it with their iPhones, but cars cost 50x as much. My guess here is that the average age of cars in the U.S. will start to push from 12.5 up closer to 17-18 by 2040. New cars are simply too expensive for consumers today given higher interest rates and inflation. Inflation is popping up in odd spots, like surging costs to repair and insure cars , and this is likely deterring some marginal buyers.

Do Tesla and other automakers have a Peloton Interactive, Inc. (PTON) problem? Pelotons sold like hotcakes for years. But the problem with Peloton was that once consumers bought one, they didn't need another one. Like many companies, they decided to pivot to focus on subscription revenue, even branding the company as "Peloton Interactive." It wasn't enough though, and they lost over $1 billion last year. I think eventually this will be a problem for stocks like Apple as well that are likely to see continuous antitrust challenges to their services businesses. We're already seeing Apple (AAPL) making a smaller net income than they were in 2021, and they're buying back tons of stock to try to keep the EPS growth positive.

If electric cars don't need as much service as internal combustion engines ("ICE") and last 15-20 years, then the auto industry will structurally not be as profitable. With the working-age population in the U.S. now declining , one might also imagine that demand for many kinds of goods and services will shrink along with it. There are still hundreds of millions of ICE cars on the road, so this isn't an immediate problem for Tesla, but it's not hard to imagine automakers playing musical chairs on a declining new car market over the coming years. If interest rates stay high due to huge government deficits, then consumers won't be able to finance as much, further depressing sales and encouraging consumers to hold their vehicles longer.

Elon Musk tweets a lot about population decline - but classical economic thought holds that population decline can actually be a good thing , and we're seeing living standards in Japan increase quite nicely with a declining population. Perhaps population decline isn't bad for the world - but it is bad for automakers and homebuilders.

It's possible that Tesla can continue to grab market share, and the electric car market is a growing market. However, the overall new car market is likely a shrinking market, at home and abroad. They're trying services, like auto insurance , for example. But these types of markets are defined by near-perfect levels of competition over time -after all it's just a commodity business. They could get big-time growth out of the solar and battery business, but that's another market with tough competition and peers you can buy for much lower valuations.

3. Can Tesla Stay King Of The Hill?

The final point here is competition. The overall new car market is stagnant, but EVs are growing. Due to this, Tesla has plenty of revenue growth potential. I don't think we should overlook the threat of competition, however. Research is showing an increasing popularity of hybrids, including plug-in hybrids.

Market share gains for hybrids are actually quite similar to EVs over the past couple of years. To this point, the electric car market might not be as big as we think in the short run. Other authors are likely to say much more than me about the pros and cons of different types of electric vehicle technology, but the important thing to know here is that the energy transition is more than just EVs and also includes hybrids.

This aside, it's clear that the EV market is growing, albeit at a more measured pace due to higher interest rates and changing government subsidies. The question is whether Tesla can remain "king of the hill."

We see Tesla's EV market share is now hovering around 50% in the U.S. (this is down), with competitors like BMW, Volvo, Audi, Porsche, and Volkswagen selling 10% or more of their models as EVs. Intuitively here, we'd expect that as consumers get more and more choices in the EV market, prices will come down and profits will normalize. Tesla was able to build a huge lead on the legacy manufacturers and take EV market share, but there's nothing inherent about EVs that should structurally change the profitability of the overall auto industry. As such, there's currently a price war going on in the EV space. EVs or ICEs, making cars is still a tough business that's highly labor and capital-intensive.

The trouble for Tesla shareholders now is that Tesla stock is priced for so much profit growth that if they stumble at all the stock will be crushed. The business might catch a cold, but at current valuations, the stock would act like it has double-lung pneumonia.

Bottom Line

Should you take the 10-15x return in Tesla, Inc. stock since 2019 to the bank? I would.

Did a bubble in Tesla stock form from 2019 to 2021? Probably.

Are you better off buying Tesla here for 74x earnings or old-school automakers for 4-10x earnings? Or both, or neither? I don't know.

Share your thoughts in the comment section!

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