- Tesla's normalized math-based valuation remains far lower than its current price, largely a function of rising inflation/required discount investment rates.
- A slowing global economy and a jump in EV competition are real-world risks to future Tesla investment gains.
- One bright spot is technical momentum trends indicate buying interest has not completely imploded with the Big Tech bust of 2022.
- I rate TSLA between a Hold for long-time owners and Musk believers to an Avoid for those contemplating adding shares.
Wild growth names are not my gig. Neither are meme picks or bubble valuations, and all the justifications you have to gulp and swallow. I will admit the Tesla (NASDAQ:TSLA) share quote has surpassed any price level I felt reasonable the last three years. But, if the Fed keeps tightening and new car sales turn lower soon, what is Tesla really worth as a buy-and-hold idea?
Let’s start by repeating inflation is the biggest problem in valuing Big Tech equities today. To keep your buying power intact, you shouldn’t be paying more than 12x to 14x P/Es on a low-growth pick right now for any privately owned business… that’s the math. The cost-of-living baseline of 8% CPI annually is a huge obstacle for Wall Street pricing. I have been screaming about the need for falling valuation ratios (and higher discount rates) since last spring in my bearish Big Tech articles.
On the huge markdowns for price during 2022, valuations in many Big Tech names have encouraged me to be more constructive on the sector generally. I have written bullish articles on the Invesco NASDAQ 100 ETF (QQQ) here, Meta Platforms/Facebook (FB) here, Netflix (NFLX) here, and Alphabet/Google (GOOG) (GOOGL) here, to name a few.
My last Tesla article in November here discussed the heightened level of insider and management selling around $1,100 per share. Hitting the skids over the last six months, TSLA's quote has declined about -30%. In my view, the main question investors still need to ponder before making any buy or sell decision revolves around the company’s underlying worth in the present economic environment of rising interest rates and weakening economic growth.
My Valuation Take
The primary bearish argument continues to be bubble-thinking investors have bid its total market capitalization into an unsustainable range, especially as competition for EVs explodes in 2022-23. Auto sales and service represented 87% of company sales in 2021.
Below is a graph describing the risk of valuing Tesla the same as (or at a premium number to) the rest of the automobile manufacturing/selling industry combined. The current $785 billion equity cap is greater than the total value of its next largest competitors Toyota (TM) (OTCPK:TOYOF), Volkswagen (OTCPK:VWAGY) (OTCPK:VLKAF), BYD (OTCPK:BYDDF) (OTCPK:BYDDY), Mercedes-Benz (DDAIF) (DMLRY), BMW (OTCPK:BMWYY) (OTCPK:BAMXF), General Motors (GM), Ford (F), Stellantis (STLA), Honda (HMC) (OTCPK:HNDAF), Ferrari (RACE), and Tata Motors (TTM).
First, some good news. Analyst earnings estimates further into the future have doubled since last summer. 2023 EPS consensus projections of $15.89 and 2024 of $18.99 have improved dramatically over the past year. You would think this outstanding income growth expectation would support the price.
However, here’s the rub. Mandated rates of investment return to keep up with inflation are completely out of whack vs. the math of 12 months ago. When you look at the current earnings yield minus CPI inflation of 8%, Tesla’s 1% or 2% income return vs. price is downright horrible. In addition, the forward 1-year PEG ratio (price to earnings growth rate) has moved from an arguably constructive and bullish area 12 months ago, to a seemingly pedestrian multiple above 1x. In terms of basic growth valuation analysis, Tesla appears to hold an overvaluation setup actually worse today than early November’s $1,200 price.
Price to earnings multiples remain in the stratosphere. So, Tesla shareholders better hope against reality that the EV push at all automakers in the next few years does not completely halt company growth soon. The current 100x price on trailing earnings is well above the 6.5x peer median average or 20x multiple on the S&P 500.
Price to trailing cash flow is also problematic for Tesla owners. A sky-high ratio of 62x is crazy expensive vs. 8% CPI increases. Of the world's automakers with positive cash flow the last 12 months, the median average multiple is closer to 4x!
On straight comparisons of enterprise value calculations (total debt + equity – cash), Tesla remains one of the most expensive automakers in the world, alongside BYD's EV effort, by an extreme margin. EV to earnings before interest, taxes, depreciation and amortization is standing at a multiple of 59x. This is against an S&P 500 index closer to 14x EV to EBITDA or the peer group median average of 6.5x.
EV to trailing revenues is equally scary from a risk standpoint. 12.4x is nowhere near the industry-typical multiple of 1x or even Tesla’s valuation of 2x in 2019. Wall Street appears to assume growth rates will not slow, no matter the level of EV sales at other automakers in 2022-23. A cautionary tale of greed and arrogance, Netflix management and investors incorrectly assumed the explosion in streaming offerings by other media/entertainment leaders in 2021-22 would not be a big deal for the king of streaming. Such feelings proved dead wrong this year, as the Netflix quote dumped from $700 to $163 rapidly, a 75% bloodbath for bulls unconcerned about competition or stock valuations. Sound familiar?
My view is Tesla should not be valued above 30x forward EPS, purely as a function of 8% CPI. An optimist will argue the company is not in the same position as Netflix a year ago, and operating business expansion will remain strong. Even under this rosy scenario, investors in Tesla paying more than 30x future EPS are LOSING 5% a year in purchasing power, if you owned the whole company outright, and pocketed income as a cash dividend.
Historically, Wall Street has priced equities at a minimum level, with income generation offsetting prevailing inflation rates (or getting close for growth picks). Without doubt, falling inflation and interest rates would benefit growth-based business valuations like witnessed at Tesla. Wall Street looks to be anticipating a big slowdown for inflation is approaching, as many growth equities like Tesla remain elevated on income and cash flow returns. But, few investors and analysts believed inflation rates above 2% were possible just 18 months ago. What if inflation rates surprise, staying between 5% and 10% YoY through 2023?
The bottom line is I am unwilling to pay 40x to 50x forward EPS for Tesla until inflation gets under control and we see how new EV competition materializes later this year. Pulling all of the pieces of the economic puzzle together, I figure a fair mathematical valuation for TSLA today is $400, likely rising to $500 in 12 months, assuming a major global recession is avoided and EV vehicle demand continues to surge.
Of course, if we get a deep recession and competition eats away at Tesla sales, a fair value closer to $300 could become reality. That would be the pessimist’s viewpoint and outlook.
Underlying Momentum Still Decent
The one saving grace for Tesla shareholders is plenty of buyers are still coming into the stock. One of the reasons for my skittishness on the world’s leading EV manufacturer back in November was lagging trading momentum. However, today my quant momentum system rates the underlying momentum condition as average vs. S&P 500 stocks, and somewhat better than average vs. the Big Tech NASDAQ 100 index.
Below are graphs of total return performance (Tesla does not pay a dividend) from 6 to 21 months vs. the largest automakers on the planet. Notice how returns have been bottom of the barrel the last six months. China’s EV competitor BYD and India’s Tata Motors are acting just as well for price gains over the past two years.
I have drawn a 22-month chart below highlighting some of the positive signals in stock trading. First, long-term Tesla shareholders have been seeing extra dollars showing up in the brokerage accounts. Even after the rough -40% drop from its all-time high last year around $1,200 per share, TSLA has still “outperformed” the S&P 500 index by better than +100%, for total returns, over the last two years.
The Negative Volume Index of buying/selling trends on low volume days (marked with the red arrow) is signaling plenty of interest by investors looking to buy weakness, especially after high-volume down days. This situation is dramatically more positive than at the peak in price last year. In addition, On Balance Volume (marked with the blue arrow) has not declined much with the sharp price dump over six months. Essentially, my read of OBV trends is selling has not been a specific issue for Tesla, but may be related to the overall Big Tech risk-off span the last six months, as a type of arbitrage move consistent with other busting names.
I peg prices under $500 per share as an intelligent area to add Tesla. If price remains above this level in 2022, I would avoid putting new capital into this revolutionary company headed by Elon Musk. I do not expect wide outperformance of the S&P 500 the rest of the year. During the 1970s period of high inflation, the extraordinary growth picks of that day traded at P/Es of 30x to 50x trailing EPS vs. Tesla's ratio of 100x today.
More than likely Tesla will continue to underperform the S&P 500 index, as it has since early November. The odds of expanding competition in EVs driving TSLA results below current expectations are very real. The company’s disruptive first-to-market inventions are no longer the only game in town.
Can I confidently say Sell Tesla? No, the company has a history of beating expectations and has regularly been priced at valuations beyond what I consider reasonable. If you have been an owner of Tesla for some time, paying capital gains taxes now, with the intent to rebuy at a price 20% or 30% lower may not work out as planned. I rate the stock a Hold for long-time shareholders, mainly because the technical trading momentum is far better than you would expect during the 2022 selloff.
For investors wanting to purchase Tesla around $750-$800, I would not be anxious to commit new capital. If this is your portfolio situation, I would Avoid the name for now. Waiting for $700 or $600 or lower seems far more logical. To me, other Big Tech names have stronger valuations in a high-inflation environment. Again, my risk/reward analysis favorites today are Alphabet/Google, Meta Platforms/Facebook, or even Netflix.
What could surprise Wall Street and support higher equity quotes over $800? Namely, a robust economy and demand for new electric vehicles, with parts shortages disappearing, labor wages increasing less fast, and a Chinese market more accommodating (both for production and sales). Something closer to nirvana, which may be too much to ask for 2022-23.
Thanks for reading. Please consider this article a first step in your due diligence process. Consulting with a registered and experienced investment advisor is recommended before making any trade.
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