Do you know the valuation of Tesla? Tesla has become quite a hot topic and commodity in the stock market these days.
Elon Musk and his company seems to be everywhere. As a result, how will Tesla shake out in 2021? Let's read on to find out.
Fundamental Valuation of Tesla
- One often thinks of fundamental value as a value that can be found with a particular calculation or process. This idea is reinforced because most stock valuations are at least partially performed by formula, at the very least a present value of future free cash flows. However, estimating those cash flows and the uncertainty associated with those cash flows can be unusual and computationally intensive. So what does that mean for the valuation of Tesla?
Such a valuation can only be done with access to specific company revenue models which aren't often available to the public.
Thus, other methods are preferable in most cases. In particular using comparables is very efficient, provided the correct assumptions and comparisons are made.
Consider Tesla (TSLA). The company is seventeen years old, and has just begun to turn a profit. It's the largest producer of electric vehicles on the globe.
Its revenue and production are far smaller than the largest automakers, yet its market cap is much larger than Ford, GM, or Toyota.
1. The Formula
Since the average trader has no specialized knowledge of automotive manufacturing or electric vehicles in particular, the obvious way to value TSLA is through comparables and also use basic understanding of the valuation of Tesla and TSLA's competitive position in the market.
Start with the following formula:
If T is the present value of TSLA, F of Ford, Y of Toyota, and G of GM, and C is the cost of capital of TSLA, then the current value of TSLA ought to be the future value of TSLA in X years, which is a function of the future or current values of Ford, Toyota, and GM, discounted to the present using C. More mathematically, it would look like
T = f(F, Y, G) / (1+C)^X
where f is a yet-to-be defined function that describes TSLA's value in the future using Toyota, GM, and Ford's present state as a comparable.
This method is much easier than projecting and discounting cash flows because we don't need to know much about autos to perform it, we only need to know what is different about TSLA and what will be different in the future.
What doe assumptions to to the valuation of Tesla? TSLA will continue to be the leading manufacturer of electric vehicles for the foreseeable future. TSLA has a decade or more head start on direct competitors.
And traditional automakers would incur a cost in switching from gasoline to electric production. In which factory equipment must be changed, and production of saleable gasoline and diesel powered cars must stop.
All of which would be difficult actions to take for management, as the risks may exceed the potential gains from switching a factory or line to electric vehicles.
TSLA will be able to produce the same number of vehicles relative to demand, as any major manufacturer today.
"Relative to demand", of course, includes specific demand for electric vehicles, general demand for vehicles in the future, and within price demands of customers.
3. Tesla Production
TSLA produces enough vehicles and has enough cash on hand to make this a reasonable assumption. Certainly TSLA could build a factory of almost any size to produce almost any number of cars with cash on hand.
TSLA commands a high price. This is borne out by the fact that TSLA cars are expensive now. And cars are often delivered months or a year after ordered.
How does that help the valuation of Tesla? TSLA is innovative. The claim that TSLA loses money on each car is probably true, and probably intentional.
TSLA has simply invested in providing innovative features at the likely real market value and is able to mix and match features to maximize profit in the future.
All these assumptions imply that at a point X years in the future, the likelihood is TSLA will be as large as any other manufacturer, have a higher net margin, and not suffer from the same level of competition as the gasoline-based vehicle manufacturers.
Additionally, TSLA is not exposed as much to the cost of fossil fuels. While much electricity is currently produced by fossil fuels, as the price of oil increases, the cost of ownership of a TSLA will increase more slowly than a gasoline-powered vehicle.
Just as high interest rates on mortgages cause home prices to decline, high cost of fuel causes car prices to decline.
How Much Is Tesla Worth?
- As of right now, Tesla is worth around half a trillion dollars. That's a lot of money! Their share prices keep increasing every day. Their market cap is over $515 billion. Which has grown a ton over the year. How will that help the valuation of Tesla?
1. Specific Assumptions for the Valuation of Tesla
In 10 years, TSLA will be as large as Toyota. Elon Musk certainly wants it to be as large as Toyota and it certainly has the capacity and demand to reach such a size.
Therefore, how does the valuation of Tesla shake out? TSLA has competitive advantages that allow it to have a net margin, say, 50% higher than Toyota.
By selecting features to maximize profit, and have less competition, TSLA has the ability to dictate its margins.
TSLA has competitive advantages that allow it to have a cost of capital, say, 1/2 of Toyota. Toyota has to compete with GM for investment money. TSLA does not.
2. Tesla vs Toyota
So what will Toyota be worth in 10 years? At a growth rate of 2% annually, Toyota's annual earnings would be approximately $22 billion.
And at the current automotive cost of capital of about 7.5%, would be worth $286b at that time. With a 50% higher margin, TSLA's annual earnings would be $33b, and at the cost of capital of
C = 50% X 7.5%, worth $880b.
Thus, in the above formula, f(F, Y, G) = $880b, and
T = / (1 + C)^10 = $608b.
Obviously this number is an estimate, due to the assumptions made. All kinds of things could make it higher or lower. A disaster impacts a plant, price of oil increases more quickly than assumed, etc.
Thus if it were correct, and the market were in agreement, we would expect it to vary quite a bit from month to month, week to week, or even day to day.
The current market capitalization of TSLA is $594b, so we can say that the market has probably arrived at a reasonable, if highly imprecise value for TSLA.
3. Valuation of Tesla and Their Capital
While a 50% discount on the cost of capital seems high, consider that TSLA has no serious competition, in the sense that its growth could be impeded.
The major automakers have demonstrated serious risks in the past, and are largely undifferentiated (all apologies to serious fans of each brand or model!) from each other, which drives their profits down to or below the cost of capital.
Frankly, TSLA could probably do better than 1.5X the margin of other automakers, given the prices Tesla charges and the wide feature-set available.
In addition, Tesla's huge war chest allows the company to make decisions on efficiencies well in advance and create new opportunities for future margin growth.
You could, of course, choose a different value for C, or a different net margin for TSLA in the above calculations.
Why would we not use these assumptions to create a list of costs and number of cars produced in future years to create a more precise value?
Quite simply, it would require expertise in automotive manufacturing and would be subject to just as much variance and disagreement as the above value.
Additionally, the future demand for cars, costs of cars, and manufacturing numbers have all been calculated for us by the market. Remember the first principle of trading?
Is Tesla Over Valued?
- The market has already decided the correct price!) in the current valuations of Toyota, GM, and Ford, because the market is paying the present value of the future cash flows of these companies, and telling us the required rate of return. So with the valuation of Tesla, you could say it is overvalued.
It seems much smarter, faster, and more accurate to rely on the experts buying and selling Ford with automotive expertise.
1. What If's
- The growth happens sooner than 10 years from now? Later than 10 years?
- Automotive demand is lower or higher?
- Tesla stays in the luxury car market?
- A small competitor like NIO gains share?
- A major competitor like Ford goes all in on electric vehicles?
- The estimates of cost of capital and earnings in the valuation are incorrect?
All excellent questions when it comes to the valuation of Tesla. All of these are possible. If Tesla grows faster or slower than the value will obviously be higher or lower.
If automotive demand changes, then all manufacturers will be affected, and that risk is already priced into the market. It seems unlikely that a CEO with Musk's attention to detail would not have many plans for all segments of the market.
The most significant risk might be something little, like Tesla being unable to brand a down-market correctly and lose sales in luxury cars as a consequence.
The likelihood people will stop buying cars, stop wanting a Tesla in their garage, or that an upstart fast-forwards a decade to surpass Tesla in technology, as well as financial, business, and marketing expertise, and finds an untapped market segment to attack?
Not very significant. A major competitor doing the same? A major competitor foregoing significant sales to inject precious capital into a war with Elon Musk?
Also not very significant. A complete transition to electric vehicles may happen over time but it will be very deliberate and not likely fast enough to derail Tesla.
What is the estimates in the above calculation are incorrect? Obviously it would change the value. However, the market seems to agree in some way.
Valuation of Tesla Conclusion
We can count on the market to help us find the valuation of Tesla; usually. However, with a CEO like Musk, promises are made but the results are underdelivered. But the market doesn't seem to care.