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thinking about Tesla (TSLA) …or it could just as well be AAPL, AMZN or MSFT

One of the bigger mistakes I’ve seen even professional investors make is thinking that you need to have an opinion about everything–and, worse, have to express that opinion in the shape of your portfolio. It’s actually much closer to the opposite–the key to success, in my view, is to have well thought out opinions about a few things where you figure you know more than the consensus and establish large enough overweights to move performance.

There are, however, stocks that have an index weighting that’s large enough that a professional simply can’t ignore them. Microsoft, for example, is the largest member of the S&P 500, making up 6.3% of the index, and is up by 52% ytd. It’s followed by Apple at 6.0% and Amazon at 3.7%, both of which have been clunkers so far in 2021. Next is Tesla at 2.5%.

The most difficult of these to get my arms around is TSLA. It’s up by 40% ytd vs. a gain of 24% for the S&P. According to Yahoo Finance, it has a market cap of $1.2 trillion and trailing-twelve-months’ earnings of $3.06/share, meaning a trailing PE ratio of 403x vs. 29.4 for the S&P. So it has already done well this year (to say nothing of its epic rise from its listing at $4 in 2010) and appears to be mind-bogglingly expensive.

On the other hand, it’s in the growing part of an essential industry, and faces competition that is really, really inept. And it’s the fourth-biggest stock in the S&P.

What to do?

In my personal case, I held the stock for a while and, uncharacteristic for me, tried to trade its periodic ups and downs. That worked pretty well. Ultimately, though, I decided I wasn’t interested enough to do the research I’d need to make a big commitment. So I sold the stock and bought one of the ARK ETFs that had a 10% TSLA weighting–essentially reducing my exposure and farming the work out to a third party. This doesn’t remove the risk–it simply shifts it from betting on Elon Musk to betting on Cathie Wood. Whether that’s an uptick is unclear, although I must think it is.

That option is arguably not the best. More important, it is generally not open to professionals. If I were still managing money for others I’d do one of two things:

–the easier alternative would be to hold an index weighting, that is, make TSLA a 2.5% position in my portfolio, freeing up my time to research other things. That way, my lack of knowledge/conviction wouldn’t affect my performance vs. the S&P no matter what the stock did.

–I could also ask myself what the end game for TSLA is. The idea would be to sketch out what the most important variables are so that I could see in at least a crude way what assumptions were already reflected in today’s stock price. Maybe this would clarify my thoughts.

Here goes:

–the world automobile market is about 80,000,000 units per year

–assume TSLA ultimately achieves a 10% market share (which would be a lot), meaning it sells 8 million vehicles/year

–let’s say the company makes $20,000 per car, implying yearly pretax profits of $16 billion

–at a current market cap of $1.2 trillion, this would be a PE of 75x, before making any allowance for tax, on earnings that are, say, half a decade away

–let’s say that in a mildly higher interest rate environment than today’s a premium PE would be 40-ish, which is around the current PE of MSFT. If so, a 75 multiple would imply that today’s TSLA price already has built in the assumption that the company is going to achieve something like 20% of the world auto market before it’s done. For the stock to go up from here, presumably belief in a better outcome than this would be needed

–TSLA could do this in one of three ways: gain a larger share of the auto market than 20%, develop large renewable energy businesses in an area other than autos or expand in another, less-obvious-today way

My thumbnail sketch suggests TSLA is pretty pricey. It doesn’t have many defensive characteristics that I can see. On the other hand, I could have made the same general argument in January. And it would presumably benefit from another round of capital flight trade like the one that dominated the US stock market in 2019-20. For a professional, then, index for now but make a note to reduce if the overall stock market waters begin to get choppy.

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