Updated: Jul 31, 2020
Truly an innovative company, Tesla fuses the technology and automotive sectors to provide eco-friendly ways to improve our lifestyles, by creating electric cars and solar panels. Headed by SpaceX CEO and PayPal creator, Elon Musk, Tesla has seen an incredible amount of growth since its IPO in 2007. Similarly, with regards to its share price, we have witnessed its incredible rise to record highs in recent months. Within this equity focus article, we will look to explore Tesla’s current financial position and its future growth prospects. Please note that this is not intended to be taken as investment advice. For more information, please see the disclaimer at the foot of the article.
Tesla’s Balance Sheet
When considering a potential investment in a company, a sensible place to start is the balance sheet. This statement gives investors a broad overview of what is happening financially within a company. It shows us to what extent a company finances its operations through debt (borrowing), or through equity (shareholders). Moreover, a company with a strong balance sheet (high net assets and a low level of liabilities) tends to offer better investment prospects. Taking a look at the below illustration, by no means does Tesla have the best balance sheet, especially compared to other well-known companies in the tech sector, such as Apple. However, Tesla’s balance sheet does certainly have some positive signs.
All numbers in thousands Source: Yahoo Finance
Looking at both Tesla’s total current assets (assets that are expected to be converted into cash within twelve months) and its total assets, we can see that the company is growing. In Tesla’s case, both these figures have been increasing year on year, most markedly between 2018 and 2019. While increasing assets is a fundamental sign that the company is growing, it is important to be aware of how Tesla is funding this asset-based growth. Is it through borrowing or through increased shareholder equity?
Moreover, when looking at a firm’s balance sheet, it is vital to compare it to other companies in similar sectors. While Tesla may identify as a tech company at heart, it is an electric vehicle automotive company. Unlike Facebook and Alphabet, who have incredibly low production cost rates, Tesla requires a huge amount of financing to make tangible products such as cars and solar panels, and this is vital to bear in mind. In comparison to Tesla’s automobile competitors, such as BYD, Volkswagen and NIO, it stands up relatively well financially. One indicator of this is the current ratio; by taking the total current assets and dividing them by the total current liabilities, we can see a company’s ability to pay off current liabilities. Tesla currently has the strongest current ratio out of all four. In truth, Tesla could pay off all its current liabilities and still be left in a strong position.
When investing in a company, it is vital to consider whether it currently trades at a discount or a premium. Is Tesla too expensive compared to its fair value, or is it a bargain? Well, below, I have considered two key ratios that will help explain whether Tesla is currently overvalued:
Price to Earnings (P/E) Ratio: This ratio tells investors what the price of the share is compared to the company’s earnings per share. With a forward P/E of 457.07, analysts believe that Tesla’s share price will be over 450x higher than its earnings over the next twelve months. While this shows that investors are willing to pay a hefty price to get hold of Tesla shares, it also suggests that the company is massively overvalued. In comparison, Volkswagen has a P/E of around 6x. A high P/E can be a sign that investors have high hopes for a company; however, in this case, it most likely means that Tesla is trading at an extremely high premium to its true value.
Price to Book (P/B) Ratio: This ratio compares a company’s market value to its book value. A multiple below one suggests that a company may be undervalued by the market in relation to its true book value, while a higher number can mean the reverse. With a P/B of around 30x, it is arguable that Tesla’s current share price is too high. Again, Volkswagen appears to be a much cheaper option, with a P/B of just 0.58x.
While these key valuation metrics suggest that Tesla’s share price is heavily inflated, we must remember that Tesla is no ordinary automotive company, nor is it a pure-play technology business. Elon Musk is an innovator, and his ideas even transcend the thinking of many other visionaries. Under Musk’s guidance, Tesla is developing driverless cars, exploring the potential for hypersonic speed travel with the Hyperloop, and considering the possibility of creating a brain chip that could cure depression and addiction in humans. Thus, although Tesla’s price may seem very steep at the moment, perhaps investors are simply speculating the possible technological advancements that Tesla, but also Musk himself, could bring to the table in the not-so-distant future.
Strong growth prospects
We all know by now that the global population needs to start changing its ways to become more sustainable to help preserve the planet. ESG is becoming an increasingly important criterion for investors, and the coronavirus pandemic has highlighted the need for a sustainable future. In this way, Tesla has a great head start; when automotive companies will be forced to change their ways from petrol/diesel-based engines to more sustainable and environmentally friendly options, Tesla will have already had several years of experience producing and delivering stylish electric vehicles (EVs). Tesla is already the global EV market leader, and this is unlikely to change in the coming years, even with greater competition.
As a society, we are still some way off a complete modal shift to EVs. For many, they are too expensive, not elegant, and inconvenient. However, Tesla is on a path to change this perception and misconception. Its Model 3 won four awards last year, including Auto Trader’s ‘New Car of the Year’ prize. The Model 3 is Tesla’s cheapest vehicle yet and suggests that there will be an increasing movement towards the production of more affordable EVs in the near-term.
In order to really thrive and attack the entirety of the automobile sector, its products need to be competing with regular cars too, and the Model 3 along with the future Model Y, which is set to be released this Autumn, is definitely a move to accommodate the lower end of the market.
As aforementioned, Musk is a visionary. For many, the strength of the management of a company can determine whether it could be a good or bad investment, and Tesla is no different.
Musk is extremely passionate about Tesla and the development of technology to help bring about a more sustainable life for humans. In fact, he sees it as his mission in life. He has been known for maintaining an extreme work ethic, that has even involved him sleeping on the floors of Tesla’s factories after working more than 120 hours per week. A hands-on, dedicated CEO is a great sign, and it is clear that Musk is willing to go to any length to ensure the future prosperity of his company. This huge amount of care and passion is admirable and shows investors that he is committed to the betterment and expansion of Tesla.
However, if you are looking for a straight-batted CEO, so to say, Tesla and Musk may not be a suitable investment. His unexpected and somewhat rash actions can often displease investors, thus negatively affecting the stock price.
A couple of Musk’s unconventional actions include the following:
On May 1, 2020, he tweeted, “Tesla stock too high imo [in my opinion].” Following this tweet, Tesla’s share price plummeted some ten per cent.
Back in 2018, while live on the Joe Rogan podcast, Musk began to smoke cannabis. Consequently, Tesla stock took a hit of roughly ten per cent, with investors worried he may be taking other drugs to sustain his 120-hour work weeks.
So, it is well worth noting when buying into a company that you are also putting your faith in the CEO. Musk is full of surprises, and when investing in Tesla, you should not expect anything less.
Tesla and SpaceX
Many investors do not view Tesla as a stand-alone company. After all, Musk runs SpaceX, so the relationship between the two is not unusual. As a result, when looking to invest in Tesla, it is vital to be aware of the effect that SpaceX can have on the EV company’s share price.
This connection offers both potential risks and rewards. Recently, SpaceX and NASA partnered to launch SpaceX’s Dragon spacecraft, an operation described by NASA as an “end-to-end test flight to validate the SpaceX crew transportation system.” With global coverage of this first-ever commercial space launch on March 7, 2020, the success saw Tesla’s stock rise by eight per cent almost immediately.
Clearly, SpaceX must be a consideration in Tesla’s share price sensitivity. Commercial space travel is a relatively new, uncharted territory, that brings with it plenty of risks. SpaceX has also endured a difficult history that involves failed projects. When investing in Tesla, this must be taken into account.
Price and Volatility
Pictured above, we see a spread of Tesla’s share price over the last year and it is impossible to miss the mostly upward trend in price over the last four months, with an increase of almost 200 per cent. This impressive rally has been relentless, seeing Tesla hit an all-time high of $1,795 per share just a couple of weeks ago. For more information on the recent price rally, have a read of our article on Tesla here. The questions that will be on the minds of every investor are: Will Tesla be able to maintain such a high price per share? Will Tesla’s share price continue to rise? At $1,480, is now a good time to invest in Tesla?
Tesla seems to have two camps of investors; those who are believers, and those who are nay-sayers. This divide is not irrational. After all, while Tesla’s price has skyrocketed beyond what many consider fair value, what is to say that this rally cannot continue?
Tesla is undoubtedly a company of the future. Musk’s endless ideas and ingenuity will likely see incredible developments in technology and products created by Tesla. Additionally, with new factories being established world-wide and cars being tailored to each purchasing bracket, Tesla has established a solid base in the market and has the perfect opportunity to grow, refine and develop its products.
Tesla’s market rally will certainly have seen investors and funds who are bullish on Tesla gain exceptionally large sums of money. However, while it has great future prospects, it is a volatile stock with an extremely high valuation. Therefore, do its current activities really merit such a high asking price? What do you think? Let me know in the comments below whether you think that Tesla is worth buying now!
The Student Investor is not a registered investment, legal or tax advisor or broker/dealer. All opinions expressed by The Student Investor are from the personal research of the author, and are written for educational purposes only. Although best efforts are made to ensure that all information is accurate and up-to-date, occasionally unintended errors and misprints may occur. Please note that the value of your investment can go up or down, and The Student Investor takes no responsibility for any decisions made by readers.