Tesla Valuation — Pin the Tail on the Donkey
While teaching a Valuation Masterclass last week, I was asked about the value of Tesla. The question of Tesla’s share price comes up often. With it comes a baggage load of emotion.
There are two extremes when it comes to opinions on Elon Musk and Tesla. Some love him and think that the Tesla share price is going to the Moon or Mars, or wherever his rockets are planning to travel to in the next millennia.
Then there are those who think that Musk is the biggest fraud since Bernie Madoff. That school believes that Tesla’s share price will crash and burn, and it is just a matter of time.
Either way, you have got to give credit where credit is due. The guy has get-up-and-go like nobody else. He has balls of steel, and he is a serial entrepreneur who never doubted himself for a second.
A common way of valuing a company is to make the least biased and most accurate assumptions about a company’s future and then discount the cash flows at an appropriate cost of capital.
Alternatively, one can construct the assumptions to produce cash flows that will result in a calculated value that matches the market share price.
In a recent YouTube video, I outlined a valuation that contained the revenue growth and operating profit margins required to produce the current share price valuation of close to $1,000. To achieve that value, Tesla would have to grow its revenues at 30% per annum for ten years and increase its operating margins from 12.9% to 22%. Doing so would make Tesla twice the size of Toyota as measured by revenue.
In the data above, a high road valuation for Tesla assumes a 35% growth in revenue for the next ten years and doubles its operating margins to 25% by year 10 of the forecast. That produces a share price value of $1,643.
The low road scenario assumes a 15% growth in revenues for the next ten years and an improvement in operating margins to 16%. That produces a share price value of $296.
It is impossible to say what the revenue growth for Tesla will be over the next ten years. As a comparison, Apple has managed average revenue growth of 23% over the last decade with average operating margins of 28%. I would argue that a 30% — 35% annual growth in Tesla’s revenue over ten years is doubtful and doubling operating margins to 25% is equally unlikely. No matter how you dress up a car company, it is not a technology software company. But I guess many people believe that it is, and that is why the share price is $1,000.
The promise of self-driving cars and ridesharing has incredible potential for value creation, especially regarding property use around vehicle storage. That value is yet to be unlocked, and it is questionable how much of the value Tesla will be able to lay claim to.
Add to that the environmental panacea that Tesla will save the planet. It appears that hype and wishful thinking on that subject are in plenty of supply.
The problem is that markets can remain irrational much longer than most investors can stay solvent.