Shares were up about 2% for Tesla (ticker: TSLA) on Thursday following news that the company beat the market’s expectations and posted a fifth consecutive quarter of profitability.
The Palo Alto, California-based electric vehicle maker and clean energy company specializes in the development, manufacturing and sale of fully electric vehicles (EVs) — providing vehicle service centers, supercharger stations and cars with ever-improving self-driving capabilities — along with solar energy generation and battery systems.
Speaking on the company’s diversified business, CEO Elon Musk said, “There’s probably in excess of a dozen startups within Tesla.” That said, cars remain its bread and butter. In the third quarter, automotive sales accounted for more than 80% of the company’s total revenue.
Year to date, TSLA shares have risen by more than 400%. After such an impressive run-up and the company’s latest earnings beat, many investors might be wondering: “Should I buy TSLA stock?” Before you make a decision, consider the pros and cons.
— Tesla at a glance.
— Pros of buying.
— Cons of buying.
— The bottom line: Should you buy Tesla stock?
Tesla at a Glance
Tesla went public in 2010, offering 13.3 million shares at $17 per share.
At the time of this writing, and after a 5-for-1 stock split in late August 2020, shares are trading for around $435 per share — meaning if you had purchased Tesla at its initial public offering price, your return on investment today would be more than 12,000%.
While that’s an impressive return on investment, it has been a volatile road to this point, marked by a history of missed manufacturing deadlines, controversial comments from Musk and a steady stream of reputable traders who denounce the company’s valuation and recommend shorting the stock.
With a market capitalization of around $400 billion, Tesla is the world’s largest automaker by value — roughly the size of Toyota Motor Corp. ( TM), Honda Motor Co. ( HMC) and General Motors Co. ( GM) combined. All those companies have taken their cue from Tesla and begun to manufacture their own electric and eco-friendly automobiles, but Tesla continues to be the dominant name in this U.S. market.
Tesla delivered a record of nearly 140,000 vehicles in the third quarter — a year-over-year increase of 44%. Despite production line disruptions earlier this year due to the pandemic, the company reiterated its 500,000-vehicle delivery target during the latest earnings call. Total revenue grew 39% year over year to $8.77 billion and adjusted earnings per share of 76 cents represented a 105% increase over the same period in the prior year. Free cash flow also reached $1.4 billion.
Tesla’s capital expenditures jumped 161% year over year as the company continues its build-out of new factories in three continents. Gigafactory Shanghai currently produces the Model 3 and will produce the Model Y, while Gigafactory Berlin and Gigafactory Texas are in various stages of development and construction. The company plans to use the facility in Austin, Texas as the main factory for the Tesla Semi and the Tesla Cybertruck, anticipated for release in 2021 and 2022, respectively.
Pros of Buying Tesla Stock
“Tesla has an unusually strong following among retail investors and among millennial investors,” says analyst Garrett Nelson of CFRA Research.
After TSLA’s 5-for-1 stock split in late August, younger investors, such as new traders on Robinhood, may find investing in the company much less daunting than just a few months ago, when the stock traded for more than $2,000 per share.
Following the company’s third-quarter earnings release, CFRA reiterated its “buy” recommendation and raised its 12-month price target to $550, implying roughly 25% upside from TSLA’s current market value. “We think there are both near-term and long-term reasons why investors should own the stock,” says Nelson.
“In the near term, the stock will eventually be added to the S&P 500 index.” This is the No. 1 reason to own shares of Tesla now, according to Nelson. After reporting its fourth consecutive quarter of profitability in July, the company became eligible for inclusion in the S&P 500.
In early September, the S&P Dow Jones Indices committee announced it added three other companies to the index: Catalent ( CTLT), Etsy ( ETSY) and Teradyne ( TER). TSLA closed more than 20% lower after the announcement — Tesla’s worst daily performance in 10 years as a publicly traded company. “The stock could regain what it lost that day in the event of an announcement that it has been added,” he says, “which could come at any time.”
In early October, the committee snubbed Tesla again when it announced the addition of Pool Corp. ( POOL), a distributor of swimming pool supplies, along with the removal of E-Trade Financial, which had been purchased by Morgan Stanley ( MS). It’s possible the committee wanted to see one more quarter of profitability under generally accepted accounting principles, or GAAP, which it did in the third quarter, meaning Tesla’s inclusion will likely happen before the end of the year. “It’s just a matter of time.”
Nelson recognizes that the company’s sky-high valuation multiples may concern auto investors. Typical measurements like the price-earnings ratio are “off the charts” when compared with other automakers. That said, many analysts don’t treat Tesla as just another auto stock. “Tesla is really a different animal,” he says, as it trades more like a tech growth stock. Most of the company’s revenue indeed comes from vehicle sales, but long-term opportunities exist for the energy and battery segments. With that in mind, and looking beyond the next couple years of earnings, “the multiples are justified,” he adds.
Looking over the long term, bullish investors place their hopes on a fully autonomous vehicles. Dozens of companies are working toward that end in one way or another, but “the approach that (Tesla’s) taking is different than all other automakers,” Nelson says. “They’re far ahead of the competition.” Many automakers working on autonomous vehicle tech — such as Ford and GM — focus on light detection and ranging, or lidar, a method of sensing the distance and shape of objects using pulses of laser light. Tesla vehicles, on the other hand, use tools like cameras, radar and GPS. The company that can be the first to “crack the code,” as Nelson puts it, will see a huge amount of pricing power and demand.
A recent report from CFRA claims, “In the event of a Joe Biden victory in November, we think auto manufacturers and suppliers focused on green and emission-free technologies, such as electric vehicles, would likely benefit.” This is based on what Biden has proposed, Nelson says, which includes generous tax credits for consumers and manufacture rs. His plan to address climate change also includes building 500,000 more EV charging stations along U.S. highways.
Cons of Buying Tesla Stock
“We view Elon Musk as the company’s greatest asset as well as (a) potential liability,” Nelson says.
Hesitant investors will cite tweet after tweet of problematic rhetoric from the company’s CEO. Perhaps the most infamous example occurred in early August 2018 when the CEO tweeted that he was “considering taking Tesla private at $420.”
After this incident, Musk was forced to step down as chairman of the board in settlement of his suit with the U.S. Securities and Exchange Commission. “Since then, he has been much more disciplined,” Nelson adds — but earlier this year, Musk single-handedly knocked billions off Tesla’s market value by tweeting, “Tesla stock price is too high imo.” That was assumed to be slang for “in my opinion.” Whatever the case, the CEO shared his candid thoughts with more than 36 million followers and caused the stock price to tank.
While plenty of analysts recommend investors sell the stock based on these antics, the truly bearish on Wall Street go even further by selling shares short. The controversy surrounding the company’s leadership is of course a big reason. “Elon Musk is a pathological liar,” according to Mark Spiegel, portfolio manager at Stanphyl Capital Partners in New York. “Under the terms of his SEC settlement, (Musk) cannot deny having committed securities fraud.”
Tesla wouldn’t be worth much if Musk weren’t around. His colossal status signals the key man risk attached to the company and its stock price. “If he were to leave the company or be terminated, it would be a big hit for the Tesla story,” Nelson admits. “A lot of the valuation reflects his presence in (the) expectation that he’ll continue to innovate and really deliver long-term value for shareholders.”
To summarize Spiegel’s short position, he says the stock is the most “decoupled from business reality” that he has ever come across. Its shareholders fall into two groups: The first are investors for whom Tesla is a religion, unaffected by financial statements or sliding market shares. The second are traders who essentially use the stock to gamble, not unlike buying and selling speculative assets , such as Bitcoin, he adds. “Eventually, it will converge with reality.”
In the third quarter, as with previous quarters, the company’s $331 million profit hinged on the sale of nearly $400 million worth of regulatory credits to other automakers. “As with all of Tesla’s previous ‘profitable quarters,’ the company lost money excluding the sale of regulatory emission credits, which it will no longer be able to monetize after next year because other automakers will have enough electric models of their own and won’t need to buy them,” Spiegel said in an email. Tesla’s “quality of earnings” has been a point of contention, Nelson says, specifically, concerning tax credit revenue, a possible barrier for inclusion in the S&P 500.
The company managed to increase its market share in the U.S. to around 80% in 2020, but bears note its difficulty selling more EVs elsewhere. “In key markets, Tesla is no longer growing,” Spiegel says. “Tesla’s electric car sales and market share in Europe is in rapid decline, while sales in China haven’t grown on a monthly basis since April.” China’s competitive EV market has led the company to cut prices multiple times in 2020. Monthly registrations for Tesla’s locally made vehicles have been stuck around 11,000 to 12,000. That’s well below the production capacity, Spiegel notes, and now the company is exporting China-made EVs to European markets.
He points to Norway as the most competitive EV market in the world and a bellwether for the future. The country’s “carrot and stick” tax system ensures a massive percentage of cars sold there are electric. Automakers introduce their EVs in Norway and emphasize it as a market, he adds. CleanTechnica reports that the cumulative year-to-date market share for plugin EVs — which includes full battery – electric and hybrids — reached 69% as of early September. The country’s best-selling fully electric car last month was the Volkswagen ID.3, followed next by Tesla’s Model 3 and Volvo’s Polestar 2 in a close third place.
The Bottom Line: Should You Buy Tesla Stock?
The ride for shareholders seems to be smoothing out as the company meets quarter after quarter of profitability.
During the third-quarter conference call, Musk said he has “never felt more optimistic about the future of Tesla than I do today.” He shared a similar sentiment in July, but after the company once again posted a profitable quarter and as shares continue to hit new highs, maybe it’s a bit easier for shareholders to accept him at his word.
Tesla has grown into the largest car company in the world. If things continue to go Tesla’s way, that’s not likely to change anytime soon. In the short term, the company’s anticipated inclusion in the S&P 500 may be the most bullish case for investing now.
And if history is any guide, betting against Musk tends to be a bad call. That said, the risks remain. Investors with interest in buying TSLA shares should add them to a well-diversified portfolio — safe advice whatever the case may be.
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