Tesla A Visionary Investment Or A Fool’s Trap?

Imagine a world where every car on the road is a Tesla, a revolutionary scenario that could radically change how we organize cities and even the entire world.

This is the belief of thousands of both retail and institutional investors. Together, they have pushed up the stock 1600% since 2019. But is the market positioning itself to rip the profits of such a revolution, or is it unconsciously creating a bubble that will hurt everyone involved with the stock?

Following my recent post on the looming recession, I want to make the argument that Tesla shareholders are in a bubble and that their investment has the potential to collapse by 93%. This might sound like clickbait, but with just a quick look at the numbers, I will prove otherwise.

The Tale of Two Giants: Tesla vs General Motors

To begin our analysis, let’s compare Tesla with one of its competitors, the century-old titan, General Motors (GM).

When looking at their financials, we can see an extreme contrast, Tesla’s price to earning ratio (P/E) stands at 71.2, while we can see a more conservative result on GM, 4.69.

But what does this really mean?

Price to Earnings Ratio

A price to earnings ratio tells you the amount of years you need to hold a stock, so the company earns back the price you have paid for it. In other words, if you would buy Tesla today, keeping all else equal, it would take 71 years for the company to earn that money back.

But why is there such a big difference between the Tesla and GM P/E? After all, it takes only 4.69 years for GM to earn their stock price back and they are both car makers.

Why Such An Astonishing Contrast?

The answer lies in the promise of the future. GM is an established business, with a predictable performance. It is a value stock, it is valued by its results. 

Tesla, however, is viewed as a market disruptor, a company that will revolutionize the sector and conquer it all. It is a growth stock, it is valued by its potential.

The market thinks they will be so disruptive, that once they take over, their gains would increase exponentially. 

In other words, investors think that the Tesla pie will be so big that they are willing to pay a very high price today to claim a piece of that same cake later in the future.

Now that we understand what the numbers mean, the next step is to answer the following questions:

• Is Tesla capable of disrupting the market?
  
• How can they achieve that?
  
• And if they achieve it, what would their earning look like?

So let’s get to it.

Robots On The Road

A way to go around this task is to imagine the most optimistic future scenario for Tesla and then compare it with its actual state. In this way, we will know how realistic or not the market expectations are.

For those who are not familiar with the car industry, there are 4 ways you can add value to a car. You can improve its aesthetics, comfort, safety, or in Tesla’s case, its efficiency.

They are aiming to revolutionize the automobile sector by making self-driving cars. But how does it make the cars more efficient?

A World Without Drivers

The average car is used around 500 hours a year, and the remaining 8260 hours, it stays in the parking lot. Now imagine a world where all cars drive without human intervention.

Now because your car is independent of you, it doesn’t need to stay parked. Now it could be used during those 8260 hours, bringing an increase of utilization of 17 times more than conventional cars.

In this scenario, we would be able to transition to a different logistic model. Instead of having your own car, we could have a much smaller pool of self-driving taxis that would be available 24/7, ready for you to use anytime you need them.

Think what that would mean for the cities. All the space that is used for cars, could be used for something else. Making this new world more efficient in terms of space, materials, and cost for the citizens. 

If we take it one step further, those self-driving cars could be connected with each other in a network. And all of a sudden, you wouldn’t need semaphores anymore, because those cars would be able to coordinate in a cross without having to stop. It would take much less time for the users to get to their destination.

As you see, the advantages of a self-driving world are enormous, and that explains Tesla’s price. Their shareholders believe in this future.

I‘m a huge advocate of efficiency, and perhaps shareholders are right in their view of the future. However, I think they haven’t done the math and they are blind to the idea of a self-driving world. So let’s challenge Tesla’s current price.

Tesla’s Hypothetical Monopoly

Let’s assume that in the future, Tesla will take over 100% of the market.

Currently, the global expenditure on cars is $2.645 trillions annually. In our Tesla-dominated world, this treasure chest would belong to them.

Today, Tesla turns revenue into profit at 12.4%. Applying this to our imagined future, their profit would skyrocket to $327.98 billion, 27.58 times their current profit.

In this scenario, Tesla’s financials would dramatically change from 71.2 P/E to 2.58. Resulting in Tesla being cheaper than GM.

Weighing Tesla’s Future

As we reach the end of this post, we should ask ourselves: Is Tesla a visionary investment or a fool’s trap?

Tesla might have the potential to change the world one day. But only in the most optimistic scenario Tesla is a good buy & hold stock. If we add on top a few what-ifs, their current price would become expensive very quickly.

Imagine for example, that Tesla faces fierce competition in self-driving technology and they capture a smaller portion of the world’s expenditure. For example, with a big 55% portion of the total, Tesla would have the same valuation as GM has today.

Also, It would not be unreasonable to think that if self-driving cars bring efficiency, the savings of that efficiency get split between the manufacturers and customers. Their revenue would decrease, making their stock price expensive.

One day Tesla will be seen as a traditional car maker. Just as GM was a revolutionary company 100 years ago and now it is a traditional business. When that happens the price of Tesla will be more or less what it is today.

In other words, there is not so much of a difference between Tesla today at a 71.2 P/E or Tesla in the future at 2.58. The stock price today has discounted all its future potential. So since there is no more upside, there is no reason to hold the stock anymore.

That is the realization investors will have during the next recession. I don’t know when it will happen, but I know for certain that it will happen before Tesla takes over the automobile sector. 

In the present Tesla is just a traditional car maker, and traditional car makers trade at a 4.69 P/E, 93% down in price from where it stands today.

Investors could sell and get their profits today or could hold onto it and risk 93% of their investment vs earning a few additional percentage points far away in the future.

What would you do? Let me know in the comments.