dealing with Tesla (TSLA)

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.

if Biden wins

As I’ve mentioned once or twice before, a former work colleague of mine was writing, presciently, as early as 1990 that neither major US political party had much relevance for ordinary Americans any longer. Democrats had a social justice program but no economic strategy; Republicans didn’t stand for much of anything, and were in danger of being captured by religious cultists.

damage from Trump

It’s thirty years later, and the basic story remains true, I think. It has set the stage for the election of Trump, an inept and unsavory businessman with anti-science and white racist views plus a fondness for dictators, especially Vladimir Putin. His campaign, to put the best face on it, called for revitalization of the South and Midwest, areas hurt by the demise of basic industry over the last half-century and abandoned by both parties, through a return he fantasized for the country to the world of the 1950s. Despite the fact that this “solution” is flat-out crazy, rank-and-file Republicans fell right in line with Trump’s idea. Many independents, too.

The results are about what one might have predicted: economic growth had slowed to close to zero even before the pandemic, foreign investment into the US was drying up; domestic firms were shifting operations abroad to escape his white racism that precluded hiring many highly skilled foreigners. In my view, we have only begun to feel the negative economic effects of his blundering. And in vintage Trump form, he has hurt most badly the people who have trusted and supported him.

The most visible damage to date from the Trump administration, however, is its epic coronavirus failure. More than simply pandemic denial, Trump has politicized routine safety precautions, like wearing a face mask, turning them into partisan political statements impermissible for his followers to make. The result has been a domestic death toll so far that’s horrifically higher than elsewhere, and pandemic cases reaching new peaks here while the rest of the OECD is at maybe a tenth of the March-April highs.

if Biden wins

If Biden wins, repairing the damage from Trump’s extending and deepening the pandemic-induced domestic downturn will be his first, and most difficult, priority, I think.

The counterproductive Trump tariffs were put in place by executive order, so they can presumably quickly and easily be reversed. The damage to the US “brand” can also be repaired to some extent by ending Trump’s anti-foreigner and anti-diversity measures.

On the other hand, the US is way worse off than it was four years ago. In addition to the unnecessary suffering and loss from the pandemic, creaky domestic infrastructure is four years older. The tax system remains unreformed, unless we call lowering taxes for the ultra-wealthy a “reform.” Because of this, the federal budget was in deficit before coronavirus-related spending. Now it’s worse. Also, as I mentioned above, in true Trumpish fashion, nothing has been done about the legitimate grievances of Americans left behind by structural change.

In short, there’s lots to do, both promises not kept and new messes made.

Government finances put into disarray by Trump will eventually have to be repaired. This process can be gotten to voluntarily or, unfortunately the more likely case, through an eventual crisis of confidence–a decline in the dollar or a refusal of professional investors to buy Treasuries. That could be years down the road, however–I truly have no idea.

the Wall Street worry: higher taxes

The front line, but specious, anti-Democrat argument is the Republican staple that Democrats raise taxes. The facile, but correct, I think, counter is that higher taxes on rising income is a better situation all around than lower taxes on lower income. We already have the latter now, with little of the really permanent economic damage Trump has put in motion having kicked in yet.

Will a Biden administration have the willingness to really reform the tax system by attacking entrenched special interest tax breaks? Who knows?

a market rotation?

The defining characteristic of the Trump presidency in stock market terms has been the extreme aversion of equity investors to stocks exposed to the domestic economy. Presumably, a Trump loss would trigger a substantial rally in laggard domestic-GDP-linked names–as cheap, with improving prospects. My guess is that Trumpish back-to-the-Fifties issues wouldn’t participate fully, if at all. Maybe their joining in would signal that the rally was nearing an end.

timing?

I don’t know. Most election experts were wrong in 2016, so I’d expect Wall Street to be cautious about reshaping a portfolio around either candidate. On the other hand, the bigger the bet that Trump is a combination “useful idiot” and George Wallace redux, the greater the outperformance over the past 2 1/2 years. This would argue for an early portfolio shift for successful managers, not to eliminate entirely the bet that Trump will continue his trademark turn-lemonade-into-lemons, but to come closer to neutral to protect gains already made. However, Trump seems to be doubling down in recent days on the idea that overt white racism and pandemic denial is his best chance for reelection. So maybe it’s too soon to think the worst is over.

a different path

I’ve always found that if I’m stuck on an either-or where I have no idea how to choose, the best thing to do is to reject the idea that I need to choose either. Maybe for me looking for names in Canada, the EU or even Japan is the way to go to reduce my Trump dysfunction bet–at least until I can see the US situation more clearly.

the biggest constant

If Trump is such a loser, why has the stock market gone up during his term?

–the biggest reason is that money policy has constantly been extraordinarily loose, partly to offset the substantial negative effects on GDP of Trump’s trainwreck trade agenda. With cash yielding nothing and Treasuries close to that, money seeking liquid investments pours into stocks. At some point, interest rates will rise and stop the flow. But with the US reeling from the coronavirus, I don’t think that’s any time soon.

–about 50% of the earnings of the S&P 500 come from outside the US. Of the rest, half comes from Europe and the remainder from emerging markets and Japan. In my view, equity investors really want the second 50% and hold the first because they’re forced to.

listening to Wall Street strategy

I was driving to a nearby Home Depot to get curbside pickup of a new work table early this morning. On the way I started listening to Bloomberg Radio, something I almost always regret. Just shows everyone finds bad habits hard to break.

I heard an interview with an equity strategist from Credit Suisse, who had been very bearish all the way up from the March lows and who has just turned bullish. One tried-and-true Wall Street saying is that the bear market isn’t over until the last bull capitulates. This could be the analogue–the last bear turning bullish. The idea behind the last bull is that after him there’s no one left to create more selling. In today’s case, it’s that all of the possible fresh cash is finally coming out of hibernation.

At the same time, though “bullish,” this strategist thinks the stock market only has 3% upside. Overall, very weird. Despite that, the last bear throwing in the towel should give us pause.

Last night, I read an article that points out the very large performance differential between the NASDAQ and the Dow. Now, a hard-and-fast rule for me is that anyone who uses the Dow as a yardstick for evaluating equities shows, just from that fact, that he knows nothing about stocks. In that sense, then, the Dow has a strange sort of usefulness.

My observation is that even Dow worshipers have noticed the huge performance gap between innovative companies that serve the world and very mature firms that are closely tied to US GDP. Yet, a counter-trend rally seems unable to gather any steam. How is this possible? My answer is that the White House continues to surprise, in finding new ways to damage the domestic economy. Whether that’s the reason or not, the question is worth thinking through.

margin calls

When I looked at my Fidelity account this morning I saw two odd things:  a simplified interface, and a message sent to everyone with a margin account (my wife and my joint account with Fidelity is a margin account, although we don’t trade on margin).  The message was essentially a warning to be on the alert for potential margin calls.

I’ve never seen this before.  A caveat:  until I retired at the end of 2006 all the family money was in the mutual funds I was managing, in whatever vehicle my employer required.  Still, I didn’t see this in 2008-09.

Two conclusions:

–Fidelity is anticipating/seeing volume increases that are testing the limits of its software (probably mostly an issue of private-company-esque aversion to spending on software infrastructure)

–more interesting, aggregate equity in the accounts of its margin customers must be dangerously (for the customers) low.  Margin-driven selloffs are typically ugly–and very often mark a market bottom.  Here’s why:

margin trading

In its simplest form, a market participant establishes a margin portfolio by investing some of his own money and borrowing the rest from his broker.  He pays interest on the margin loan (Fidelity charges 5% – 9%+, depending on the amount) but all of the gains/losses from the stocks go to him.  The client does relinquish some control over the account to the broker.  In particular, the broker has the right to liquidate some/all of the portfolio, and use the proceeds to repay the loan, if the portfolio value minus the loan value falls below specified levels.

Before liquidating, the broker tells the client what is going to happen and gives him a short period of time to put enough new money (securities or cash) into the account to get the equity above the minimum amount.  This is a margin call.

If the client doesn’t meet the call, the broker begins to sell.  The broker has only one aim–not to get the best price for the client but to convert securities to cash as fast as possible.  Of course, potential buyers quickly figure out what’s going on and withdraw their bids.  Carnage ensues.

That’s what Fidelity was saying we’re on the cusp of this morning.

There are some very shrewd and successful margin traders.  Around the world, though, retail margin traders are regarded as the ultimate dumb money.  That’s why seeing forced selling from these portfolios is typically seen as a very positive sign for stocks.