If the question came up about whether to buy TSLA at $1400 (I have no intention to do so), how would I decide?

If I were making a recommendation to someone else I’d do a detailed spreadsheet in which I’d try to project the level of future earnings, the rate of their growth and how long I thought the superior growth would continue.

Today, I’m going to do a quick, back of the envelope, calculation. My aim is to get an idea of what level of future earnings is already reflected in the price of TSLA.

valuation

Let’s say the current price is $1400 a share. The market cap is $260 billion, implying that about 185 million shares are outstanding. Let’s say that I would be willing to pay 30x future earnings for TSLA, once it starts to earn on a regular basis. That implies earnings at some point of $45 a share, or earnings of about $8.5 billion a year, to justify today’s price.

Let’s assume this all comes from selling electric cars. Let’s put the average selling price at $40,000 and the net profit to TSLA from each at $4,000. If so, how many cars does TSLA need to sell to make $8.5 billion? The answer is 2.2 million units. That’s as many as Mercedes or Kia or BMW do and would put TSLA at the low end of the top ten global auto brands.

If I’ll only pay 20x earnings for an auto company, TSLA has to sell 50% more vehicles, or 3.3 million, to get the $1400 share valuation. That would put the company in the lower middle of the top ten, somewhere around Chevrolet, Hyundai or Nissan.

Is that doable? Well, the American car companies, operating in a heavily protected market, have been by and large pretty sorry companies for most of my lifetime. The Europeans are currently embroiled in a scandal that’s resulted from widespread falsification of emissions testing results for the diesel cars they sell in their home markets. The chaebol and zaibatsu conglomerate structures in Korea and Japan mean profits and innovation are at best secondary considerations. In other words, the competition isn’t particularly stiff.

The world market is about 70 million units annually, so 3.3 million would be around a 5% market share. Again, not impossible–although at the high end of what traditional auto companies have been able to achieve recently.

time

How long will it take for TSLA to be able to manufacture 2 million+ cars a year? The company was making them at a 400,000 unit annual rate at the end of 2019. At a 30% growth rate, it would take close to ten years. At a 50% growth rate it would take four or five.

In other words, today’s stock price is discounting very large growth for TSLA and paying today for earnings that are easily a half-decade in the future. What I think is significant about this is that in my experience the US stock market rarely discounts earnings more than two years ahead. How so? Pre-financial crisis studies (when there were lots more experienced analysts) show that securities analysts aren’t able to make accurate earnings forecasts more than a year ahead. Also, how far in the future the market is willing to discount is also a measure of market bullishness. I’ve rarely seen markets where investors are willing to pay today for estimated earnings three years in the future. Eighteen months is more usual. In bear markets, no one pays for any future earnings! In this case, though, the market is willing to pay for profits much farther ahead than in typical bull markets.

my take

I can imagine a world where TSLA is the leading maker of electric vehicles, with a global market share of, say, 10% and where electric vehicles are the dominant form of ground transportation. That outcome is not in the current TSLA price, in my view. But my guess is that if this happens, it’s also at least another half-decade in the future. Unless/until enough time passes that the market wants to pay for this, my guess is that TSLA will be at best a market performer.

I think the market’s willingness to discount far into the future is primarily a function of super-low interest rates. There’s also the sense that substantial structural changes to global economic life are in the offing and that it’s important to have a portfolio oriented toward companies of the future rather than those of the past. But if fixed income investments were to become more attractive–that is, if interest rates were higher–portfolios would shift toward bonds. At the same time, I think, the discounting mechanism in the stock market would become more conservative/less willing to look five-ten years ahead. That would spell trouble for TSLA …and many other tech-ish names.