April 25, 2020
Understanding Tesla Valuation: Too High Or Too Low?

Tesla’s business is in uncharted territory. Tesla passed their all-time high valuation of $66 billion a couple weeks ago, and has been breaking valuation records almost every day since. But now that Tesla is worth over $80 billion, more than double the valuation of traditional automakers like Ford, how might investors think about valuing the business from here?

More specifically, what tools can we use from stock market history to understand whether Tesla stock is valued in a “zone of reasonableness”?

While there is no perfect parallel company to compare Tesla’s business to, there are lots of companies that resemble sections of Tesla’s business.

Tesla manufactures, writes software, and performs services. None of these businesses alone are novel. So by splitting up Tesla’s business into individual units, investors can compare other companies against Tesla based on their view of what kind of company Tesla might become.

Some consider Tesla to be an automaker, while others believe it to be a software company, a hardware company, or even a hybrid combination. So we’ll analyze all these business models, and compare Tesla's current valuation to a handful of data points from stock market history.

How Tesla Compares to Amazon, Apple, And More...

Now that Tesla is worth more than $80 billion USD, let’s look at examples of 4 types of companies that have also surpassed that valuation, and their operational results at the time they passed this barrier. But first, we need some baseline numbers from Tesla.

Tesla broke the $80 billion valuation mark in Q1 2020. Below are some of Tesla's key milestones and metrics from the past year (Oct ‘18 - Sep ‘19, since that's the most recent data available).

Revenue: $24.4 billion USD

Operating Margin: 0.6%

Net Income: - $827 million USD

Revenue Growth Rate (avg of last 5 years): 53.6% annually

One important note: These figures will change with the release of Tesla's Q4 financial statements in February. I expect net income for FY2019 will be roughly $0, with improvements to operating margins as well. I expect revenue will increase by roughly $800 million.

Now that we have a set of baseline figures, let’s see how Tesla compares to different types of companies that have also passed the $80 billion valuation mark.

Toyota (Auto Manufacturer)

Toyota broke the $80 billion valuation mark in Q4 of 1996. This was a banner year for the company, and it took another 8 years until the company would surpass the revenues of ‘96/’97. By that point, this now famous book had been published and Toyota started to gain worldwide recognition as the world’s best manufacturer. Let’s examine Toyota’s key milestones and metrics that year (Apr ‘96-Mar ‘97).

Revenue: $108.3 billion USD

Operating Margin: 5.4%

Net Income: $3.4 billion USD

P/E Ratio: 23.5

Revenue Growth Rate (avg of last 5 years): 0.3% annually

Valuation 12 months later: $79.7 billion USD (0.4% down)

Nvidia (Hardware Manufacturer)

Nvidia broke the $80 billion valuation mark in Q2 of 2017. Their GPU business found product-market fit in the fast-growing fields of gaming, AI, and driverless car systems. This was clearly an inflection point for the company, as they were worth over $150 billion the year after they crossed the $80 billion threshold. Let's examine Nvidia's key metrics that year (Feb 2017-Jan 2018).

Revenue: $9.7 billion USD

Operating Margin: 33%

Net Income: $3.1 billion USD

Revenue Growth Rate (avg of last 5 years): 17.8% annually

Valuation 12 months later: $150.1 billion USD (87.6% up)

Amazon (Software Marketplace)

Amazon broke the $80 billion valuation mark in Q4 of 2010. At the time, the company was already working on many of the solutions that make up the Amazon we know today. Amazon AWS, Amazon FBA, Amazon Advertising, and many more services were already core parts of Amazon in 2010. Let's examine Amazon's key metrics that year (Jan 2010-Dec 2010).

Revenue: $34.2 billion USD

Operating Margin: 4.1%

Net Income: $1.2 billion USD

Revenue Growth Rate (avg of last 5 years): 32.1% annually

Valuation 12 months later: $88 billion USD (10% up)

Apple (Software/Hardware/Services Hybrid)

Apple broke the $80 billion valuation mark in Q4 of 2006. In 2006, the iPod and the Mac were Apple’s two major revenue drivers. And while everyone knew about the upcoming iPhone launch expected in 2007, it was still uncertain how well Apple’s new phone would fare against competitors. Also, the App Store didn’t launch until July of 2008, and many of Apple’s high-margin services today like Apple TV+ and Apple Pay weren’t even being considered as potential businesses. Let’s examine Apple's key metrics that year (Jan-Dec 2006).

Revenue: $20.7 billion USD

Operating Margin: 14.6%

Net Income : $2.4 billion USD

Revenue Growth Rate (average of last 5 years): 29.2%

Valuation 12 months later: $160 billion (100% up)

Thoughts on Tesla's Market Cap

After examining the four companies above, it’s clear that Tesla’s financials most closely resemble those of Amazon and Apple.

This is not to say Tesla’s business is exactly like Amazon or Apple, or that we can’t learn anything from Toyota or Nvidia, but Amazon and Apple will give us more clues to how Tesla should be valued.

Tesla at $80 billion market cap vs Apple and Amazon at $80 billion

Though Tesla’s operating margin and profit figures are slightly lower than both companies, Tesla is also growing much faster than both Amazon and Apple. This compensates for the lack of profit… for now. And this leads us to the ultimate question Tesla investors need to ask themselves.

Can margins improve as growth slows?

Because 50%+ YoY revenue growth isn’t a sustainable strategy for any company. Eventually growth will slow. But with a powerful moat, high profit margins can be sustained for many years.

Tesla High-Margin Opportunities

So when we think about valuing Tesla’s business, we should be on the lookout for high-margin opportunities that may transform the company from a low-margin manufacturer to a high-margin hybrid business. One way Tesla is starting to earn high-margin revenue is by stacking services on top of Tesla vehicle sales.

Apple took this approach, and transitioned their business model from computer manufacturing to a hardware/services hybrid. It’s possible that Tesla could pull off a similar feat, but the magnitude of Tesla’s additional services revenue is still uncertain.

Beyond add-on vehicle services, the Tesla Network is the next best bet for generating high-margin revenue. With a fleet of roughly 1 million Tesla vehicles on the roads, a 30% cut on every Tesla Network ride can add up very quickly with minimal cash outlays.

The only hurdle Tesla needs to overcome (albeit a very large one), is the completion of full-self driving vehicle software. Without it, this high-margin revenue source disappears.

And all this uncertainty creates the perfect storm for investors.

Growth and margin expansion will define the future of Tesla’s valuation. Right now, Tesla’s margins are lower than all the companies mentioned above, but their growth rate is higher than them all too. And the fact that Tesla’s high-margin business opportunities and growth opportunities remain uncertain means there is still a ton of money to be made for investors on both sides of the stock.

Investors, place your bets.

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