The fundamental question investors must ask about Tesla

It can be well argued that on fundamentals Tesla should not be trading at as high as its current $US800 per share level. So buying in now carries significant risk.

Those investors that understood that the future of the automotive industry was electric and that Tesla was the best way to play that trade shouldered the early risk. Even those that bought the stock as recently as the start of 2020 have ridden the share price up from the $US100 level.

They have profited from the index money that has poured in in recent months.

But active fund managers with offshore portfolios who stood on the Tesla sidelines over the past year have seen their relative performance eviscerated.

On a risk adjusted basis and using the usual valuation criteria Tesla shouldn’t be trading anywhere near this price. For the most part analysts agree. On average those from mainstream investment banks have a valuation of roughly half the current price.

In recent weeks a few major analysts have updated their price targets to be closer in line with Tesla’s current share price. But in most cases, they have needed to throw out conventional valuation criteria to do so. In other words they have adjusted their models to justify the current share price.

In part the meteoric rise in Tesla’s share price has caught analysts apparently wrong-footed. It is very difficult for analysts to endure the pressure of placing a valuation on a stock at half (or less) of its trading price.

It is additionally tricky when their institutional clients are buying in at elevated prices.

Based on near term earnings -in other words profits that can reliably be modelled – the price earnings multiple of Tesla is nonsensical.

And it is the six months to two years out revenues and cash flow on which most valuations are based.

Instead those valuing the stock at closer to today’s trading price have estimated manufacturing volumes, and sales on what Tesla might achieve in five, six or seven years.

That itself is a risky methodology because a lot can change and many snafus can take place over such an extended time frame.

(Having said that Musk has delivered on most of his promises, albeit not in the precise time frame.)

If one assumes Tesla can move seamlessly from its current annual production of half a million cars to say 4 or 5 million and produce earnings before interest tax depreciation and amortisation of $US40 billion in 2027 – the multiple based on today’s share price would be around 20 times. (There are very reputable analysts quoting these kinds of numbers – even though Tesla isn’t.)

That is an acceptable multiple on which a company like Tesla should trade.

Whether Tesla can get there is another matter.

Firstly it should be noted that most sensible people now understand that the future of motor vehicles will be electric.

Even the petrol engine car makers appreciate this and many are already manufacturing small numbers of electric cars.

The history of disruption has demonstrated that the ‘disrupted’ are slow and unwilling to ditch the incumbent products and the vast capital invested manufacturing them to re-tool – even if it is in their long term interests.

Thus to the extent there is a moat protecting Tesla from existing petrol engine manufacturers,it is time.

Additionally there are a few new electric-only car makers emerging including China’s answer to Tesla – NIO which is backed by Tencent. Another Chinese entrant in the electric car space is Baidu sponsored Geely. Even Amazon has dipped its toe in the EV pond with the 2020 acquisition of self-driving taxi company Zoox.