Is Tesla’s Rally a Matter of Irrational Exuberance?

Lior is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I have recently came across an interesting article in the Fool’s network regarding the valuation of Tesla Motors (NASDAQ: TSLA) and if investing in the company’s stock is prudent. This made me think about the staggering growth of Tesla’s stock during the year (nearly 330%), which raises some questions about the value of Tesla.  for instance, is this company’s valuation off the charts? Do Tesla’s investors make a well informed decision to buy the stock, or is it just a matter of irrational exuberance?  

The author of the article considers the best scenario circumstances to evaluate the potential return for Tesla’s investors over the next nine years assuming Tesla will meet its management’s goals. The conclusion: Tesla’s ROI isn’t high enough compared to the S&P 500, which could mean the company isn’t giving a high enough return or isn’t setting ambitious goals over the next several years. I think this analysis is better suited when trying to evaluate a company in an established industry, and using such an analysis in the electric car market might miss be misdirected.  

If an industry is well established it’s possible to make a projection or valuation over time. For instance, in the car industry it’s possible to estimate the valuation of a company such as Toyota Motor (NYSE: TM). The company’s current enterprise value-to-EBITDA ratio is approximately 7.84 (based on the company’s past twelve months’ operating income). Nissan Motor (NASDAQOTH: NSANY.PK) has a ratio of 4.56. In comparison, the automotive industry’s average EV-to-EBITDA ratio is 5.81. This means Toyota’s current valuation is slightly higher than the industry’s average; Nissan’s valuation is slightly lower. These valuations for Toyota and Nissan could be used as rough estimations because the car industry is well established; this isn’t the case for Tesla, a company that heavily relies on a sharply growing and relatively new industry. 

According to the Electric Drive Transportation Association, during the first seven months of 2013 the number of Hybrid, Plug-in Hybrid and electric cars sold rose sharply by 30%. The number of electric cars sold spiked by 417% (year-over-year). Nonetheless, this wasn’t the case for Toyota and its Hybrid brad the Prius: in the first half of 2013, car sales fell by 5.1% compared to 2012. The company might not even reach its 2013 goal in sales, which could adversely affect the company’s stock price. On the other hand, Tesla has reflected the staggering rise in demand for electric cars as its net revenues jumped by over 3,500% in the first half of 2013. And yet, during the year, the company still loses money on its operations.    

The strong sale of Model S and the good reviews it had received helped augment Tesla’s revenues: during the second quarter, 5,150 Model S cars were sold – higher than Tesla’s 4,500 target sales. Despite the sharp rise in electric and hybrid car sales, they still account for less than one percent of the total number of cars sold in the U.S.  

Here are several factors that could explain why any attempt to estimate the potential growth of Tesla over long period of time isn’t realistic:  

  1. Legislation: The future steps of U.S policymakers could determine the developments of the electric car industry. If policymakers will augment the tax credit on electric cars this could drive higher demand for this type of car. Up to now, U.S policymakers promoted the sales of electric cars by providing tax benefits that can come to $7,500 in tax credit on a federal level. The tax benefits are not only federal: in certain states, such as California, the tax credit could come to an additional $2,500. Tesla isn't the only company that benefits from these incentives: Toyota Motor’s Prius Plug-in Hybrid is also eligible for $2,500 federal tax credit due to its small battery. Buyers of Nissan Motor’s Leaf brand also receive a $7,500 in federal tax credit.
  2. Future innovation: This factor affects almost any industry, but for a market that is very small in such an early stage this could determine its growth rate. The main issue will remain the miles the electric car can go without recharging. Currently, the Model S’ battery can max out at 265 miles, which is almost half the miles a regular car can do with one full tank. Moreover, the high price of electric cars, even with the current tax credit, will still keep the demand for this car low.
  3. Competition: Tesla is currently leading the way in the electric car industry, but if other companies continue to invest in this type of car, it could become harder for Tesla to keep expanding at its current pace. Nissan's Leaf brand is also showing sharp signs of growth: during the first seven months of 2013, the company sold 11,703 cars. This represents a 230% jump in number of cars sold compared to 2012 (year-over-year). So Tesla isn’t the only company sharply growing in this industry--Nissan is also a strong competitor in the electric car industry and could impede Tesla’s growth in sales in the near future.
  4. Even management gets it wrong sometimes: Many consider the current expectations of the management as the “best case scenario.” This might not be the case because even management’s expectations are sometimes low compare to the potential outcome over long period of time. In 1996, could Apple’s management (before Steve Jobs’ comeback) have predicted the company’s meteoric rise over the next decade? 

The bottom line

I think Tesla investors should not worry about the company’s high PE or it’s not too high ROI compared to the S&P 500. If the company continues to dominate this industry in the next decade and the electric car market keeps up its staggering gains, Tesla’s current valuation won’t seem too high in hindsight. Finally, the uncertainty around this industry in general and this company in particular is high; this uncertainty also entails potentially high reward, which could exceed even management’s expectations. 

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Lior Cohen has no position in any stocks mentioned. The Motley Fool recommends Tesla Motors . The Motley Fool owns shares of Tesla Motors . Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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