By Steven Carroll, Independent Commentator
Imagine that you're sitting at your desk in 1994. You're reading a report about the mobile phone industry - the new technology of the age. The article correctly forecasts all the potential benefits to come - the smart phone revolution, continued miniaturization, navigation via inbuilt GPS, mobile transactions, online flight check in, boarding passes, etc.
If the article was incredibly prescient and identified all the industry's twists and turns of the next 20 years, try and imagine what stock recommendations might have been made. Motorola - yes, an early leader. Nokia? Maybe - the first GSM handset, the 1011, was released two years earlier. Samsung? Maybe, the SH770 was released in late 1994 and marked the first time the company's product was considered on par with Motorola. HTC? No, first phone and PDAs were around 2002. BlackBerry/RIM? No, the first Pearl shipped in 2006. Apple? No, iPhone launched in 2007.
Now consider the bright future of the electric car and look at Tesla Motors Inc. (NASDAQ:TSLA). Try to imagine the competitors who will enter this space, the new technologies, the responses from the existing players who have cash flow to burn on research - and look at Tesla's valuation, a forward P/E of 112, 36 times book value.
Every new technology is somewhere between evolutionary and revolutionary, and every time human nature gets excited about a new technology we eventually discount all of the risks - assuming flawless execution, a continued absence of competitors and that this will remain the only stock in town. If we return to the mobile phone analogy, no one could correctly anticipate the changing industry dynamics. Yet Tesla's current valuation implies 44.7% EPS growth every year for the next 10.
It's hard to think I'm the only one with such skepticism over these punchy multiples. Tesla also happens to be within bottom 2% for the StarMine Short Interest model, meaning the hedge funds are already positioned for a fall. Unlike many quant factors, the crowded trade actually tends to work. When professional traders are short there tends to be a subsequent underperformance - in other words this factor does deliver alpha.
Compare to Cisco
For those of you who are short term traders - just riding stock momentum - all these valuation factors and longer term considerations are unimportant - but for those thinking you can just buy and hold in a new technology space - I'd urge you to reconsider.
Consider the chart below from Thomson Reuters Eikon. This is Tesla over roughly the last four years alongside Cisco (NASDAQ:CSCO) (once, the new new thing). I've then included an eight-year view of CSCO from 1996 to 2004 to give you a sense of what happens when a bubble bursts. Remember, the hype was correct - CSCO did continue to grow and people kept buying routers - but not at the silly rate the market had been implying through the late 90s. Click to enlarge
Disconnected from growth
I suspect Tesla will be hugely successful. However, the argument is - what level of success is already assumed to be a certainty at the current valuation level, and considering the last 10 years how comfortable are you with 'certain' predictions?
The CSCO chart should serve as a salutary reminder that a stock's fundamentals can be solid, with high growth, but that won't save the stock price if the valuation has completely disconnected from achievable longer term growth.
I have no idea what will happen in the next five years. Looking at the current valuation, a stockholder seems to have an asymmetric risk profile, a modest chance that the stock will outperform lofty expectations and a significant chance that there'll be challenges. These may be from execution, competitors, margins, resource supplies - who knows. But since none of those challenges are even vaguely considered in the current valuation - I'd be awfully cautious. For the trader - keep an eye on the StarMine Analyst Revisions Model. If analyst upgrades should falter, watch out below.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.