Tesla (NASDAQ:TSLA) shares initially rallied 10% this week when the stock was finally added to the S&P 500. The inclusion was a catalyst that investors had anticipated for months and has nothing to do with Tesla’s business.
It’s now been six months since Tesla CEO Elon Musk expressed skepticism about Tesla’s stock price. “Tesla stock price is too high imo,” Musk tweeted on May 1.
Since that tweet, Tesla’s share price is up another 217%.
I’ve never seen a “genius” that gets things wrong as often as Musk does. But I believe he got this call right.
Tesla Stock Valuation
Back in May, Musk was addressing Tesla’s skyrocketing valuation when he said the stock price was too high. Since that tweet, Tesla has reported two very impressive quarters. In the last two quarters, Tesla has averaged 17% revenue growth and adjusted earnings per share of $1.28. Of course, Tesla’s automotive business is roughly break-even on profitability without the sale of regulatory credits. That regulatory credits cash cow will dry up completely for Tesla in the next year or two given all the new electric competition coming.
Tesla’s 17% sales growth in such a difficult environment is impressive. Analyst are projecting 35.3% revenue growth in the fourth quarter for Tesla, which would be even more impressive. However, the valuation problem that Musk identified back in May is only getting worse. At the time of Musk’s tweet, Tesla shares were up 199% in a year. In the six months since, they have more than tripled.
It would be one thing if Tesla had previously been trading at a significant valuation discount to other auto or tech stocks. That type of share price outperformance might be warranted. Instead, Tesla has been trading at a steep valuation premium to its peers for years.
Wall Street analyst are all over the map when it comes to Tesla. Stock analysts are notoriously biased toward “buy” ratings, but not when it comes to Tesla. Of the 37 analysts covering the stock, only 12 have “buy” ratings. Another 11 have “sell” ratings. The most common rating for Tesla is “hold,” which in my mind represents 14 analysts that are throwing up their hands and saying “I give up!”
Bank of America analyst John Murphy recently said Tesla’s “hyperbolic stock run needs hyperbolic unit growth” to back it up.
This seems like common sense. A company that grows sales by 35% can’t have a stock price that rises 500% or more per year. That is an unsustainable situation.
“The burden of proof remains for TSLA that its unit volumes are reaching ‘escape velocity’ from what has been some lackluster/disrupted quarters recently,” Murphy says.
Bank of America has a “neutral” rating and $550 price target for Tesla.
Morningstar analyst David Whiston says Tesla’s profitability and growth have been impressive in recent quarters.
“It is important to keep the hype about Tesla in perspective relative to the firm’s limited, though now growing, production capacity,” Whiston says.
Morningstar has a “neutral” rating and $319 fair value estimate for Tesla.
How To Play Tesla
Whenever I write negative or neutral stories on Tesla, I always get messages about the company’s long-term growth outlook. But here’s the deal– Tesla’s market cap is already $390 billion. The stock trades at 13.8 times sales and 104 times earnings. Yes, Tesla may generate 10 or 15 years of growth to eventually justify that valuation. I’m not arguing against that growth. But if it takes Tesla 10 or 15 years to grow into its current valuation, where is the upside for investors buying today?
Tesla is by far the largest company ever to be added to the S&P 500. But there’s a reason for that fun fact. At no time in history has a company the size of Tesla ever failed to qualify for the S&P 500. In other words, the market has never assigned such a massive valuation to such an unproven company in the history of the S&P 500 index.
At best, buying Tesla in the middle of an EV stock bubble is a huge risk. At worst, buying Tesla will end up being a costly mistake. There is only one place to be when it comes to Tesla–on the sidelines. Elon Musk was right this time. Tesla’s stock price is too high.