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Tesla’s (NASDAQ:TSLA) inclusion in the S&P 500 is yet another feather in the cap for Elon Musk’s $600 billion baby. Tesla stock soared to a record high on its inclusion in the index. It caps an amazing year for the electric-car maker, which is leading the electric-vehicle frenzy.
Source: Grisha Bruev / Shutterstock.comNonetheless, despite the positivity surrounding Tesla stock, fears about its valuation are emerging. About two-thirds of the analysts who track Tesla have a “sell” or a “hold” call on the stock.
That may seem strange, given Tesla’s popularity among investors which has rivaled that of the FAANG stocks. Of course, the latter acronym is used to describe the five most popular and best-performing American technology companies: Facebook (NASDAQ:FB), Alphabet (NASDAQ:GOOGL), Microsoft (NASDAQ:MSFT), Amazon (NASDAQ:AMZN), and Netflix (NASDAQ:NFLX).
However, several analysts are anticipating the long-awaited (by some) reconciliation of Tesla’s valuation with the firm’s fundamentals. Their hopes have come to naught despite the automaker’s intense competition in China, sluggish European demand, and quality-control issues. However, markets have a way of catching up with stocks eventually. Any way you slice it, Tesla looks obscenely overvalued.
But betting against Tesla stock is a dangerous proposition. Short sellers have lost so much money betting against the company that it was dubbed the “widow-maker trade of 2020.”
However, I believe that there is still merit to the contrarian view.
Tesla Stock Is Leading the EV Mania
EV companies are among the world’s most valuable automakers. Tesla alone is not responsible for this trend. Governments the world over are getting more conscious of the need to tackle climate change. With every passing year, we see stricter regulations against internal-combustion cars.
On Sept. 23, California Governor Gavin Newsom signed an executive order requiring all new cars sold in the state to be zero-emission vehicles by 2035. In the same month, Chinese President Xi Jinping announced plans to expand his nation’s Paris climate-accord target. Xi now aims to achieve a peak in carbon dioxide emissions before 2030 and carbon neutrality before 2060.
The sales of new-energy vehicles (NEVs) in China is expected to surge to 50% of overall new car sales by 2035 from 5% currently. According to the China Society of Automotive Engineers, 95% of the NEVs sold in 2035 will be battery-electric vehicles.
Amidst this backdrop, one can understand Tesla mania a bit better. However, the stock’s meteoric rise speed has defied even CEO Elon Musk’s expectations. “I actually said the stock was too high a long time ago,” Musk said at the start of December. “But they didn’t listen to me.”
Tesla stock’s valuation has become divorced from the company’s underlying fundamentals. Retail traders are making sure the company exists in a bubble that has nothing to do with its ability to produce, sell, and service cars profitably.
Last Man Standing
For years, Elon Musk’s cynics have shorted Tesla stock, placing bets that the clean energy company’s stock value would collapse. But according to an analysis by S3 Partners, the short sellers of Tesla’s shares have lost $35 billion on that trade so far this year.
Many of those who shorted the stock have thrown in the towel. The number of shares of Tesla held by short-sellers is down 63% in 2020.
That must be particularly satisfying for Tesla CEO Elon Musk, who has made no secret of his hatred of short-sellers. He famously said short-sellers are “jerks who want us to die.”
Musk, however, cautioned his employees in an e-mail recently that if they don’t work to control costs, causing investors to begin to doubt its financial guidance, “our stock will immediately get crushed like a soufflé under a sledgehammer!”
Still, most analysts have stopped assuming that Tesla stock will magically crater back to earth. In fact, many believe that the shares can climb further.
Wedbush analyst Dan Ives recently upgraded Tesla stock, placing on the name a “bull case” price target of between $800 and $1,000. He believes the substantial increase in global demand for EVs justifies the company’s valuation.
Tesla appears to have seen strong demand for its Model Ys in China during November. China is key to Ive’s bullish thesis. He says that the nation is worth $100 per share to Tesla and is critical to its future success.
A Rare Contrarian View
Earlier this month, a JP Morgan analyst said, “We recommend investors not weight Tesla shares in their portfolio in equal proportion to the S&P because Tesla shares are in our view and by virtually every conventional metric not only overvalued but dramatically so.”
That statement was surprising. Most Wall Street banks are now touting what they see as Tesla’s positive growth outlook. For example, Goldman Sachs recently upgraded the stock from “neutral” to “buy,” boosting its 12-month price target from $455 to $780. Goldman’s analysts cited the acceleration of EV adoption, an increase in regulatory proposals to restrict or ban the sales of vehicles with internal-combustion engines in the coming decades, and the incoming pro-EV Biden administration as major catalysts for the shares.
Goldman also noted that betting against Tesla stock is tough. The firm had downgraded the shares in June after Tesla reduced its prices more sharply than expected and had quality-control issues with its Model Y vehicle.
However, the expected slowdown did not come to pass. Tesla has reported five consecutive quarters of profits. It delivered 139,300 vehicles in Q3, smashing its previous record of 112,000 deliveries.
Even famed Enron conqueror Jim Chanos is shorting fewer Tesla shares after five “painful” years of betting against the company. The famed short-seller, however, continues to have issues with Tesla’s business model and valuation.
An Academic View on the Overvaluation Debate
I recently caught up with Keith Czerney, assistant professor of Accounting & Deloitte Faculty Scholar at Missouri University, and asked him about Tesla and its outlandish price-book ratio. I also asked how investors should deal with equities whose fundamentals and stock price appear to be so disconnected.
I think investors need to have an understanding of fundamentals and conventional valuation ratios, in terms of knowing how they are calculated and how to incorporate them into their decision-making. They also need to look at multiple multiples, rather than just fixating on one metric because, in many cases, a single data point does not tell a complete story. After reflecting on the multiples and potentially acknowledging that they are out of line relative to historical averages (e.g., Tesla) if investors choose to make an investment anyway, they need to be aware of the potential downside risks and rapid corrections that can occur in companies that trade at high relative valuations.
Investors ultimately need to exercise discipline, trust their analysis, and not fall prey to psychological biases that drive sub-optimal decisions.
Tesla Stock Needs to Cool Down
Betting against Tesla is not for the faint-hearted. It’s also true that Tesla delivered an all-time high of 139,300 vehicles in Q3. Its long-term shareholders are enjoying the fruits of their investments.
But across the board, every valuation metric is screaming that the stock is overvalued. You cannot ignore these signs. Analysts have an average 12-month price target of $396 on the shares, about 35% below its level in late-morning trading today.
Plus, even the arguments that most bullish analysts make have holes in them. For instance, Tesla is not the only racehorse in China. NIO (NYSE:NIO) and Xpeng(NYSE:XPEV) are well-entrenched in the market. Meanwhile, Dongfeng(OTCMKTS:DNFGF), BAIC, GAC (OTCMKTS:GNZUF), Chery, BYD(OTCMKTS:BYDDF), and Geely (OTCMKTS:GELYF) are also making significant inroads there.
The Chinese are also famous for supporting their own brands; Beijing used a $1.4 billion loan to bail out Nio after its sales dried up due to the novel coronavirus.
Plus, although EVs are in vogue, the oil and gas sector is not dead. According to pre-pandemic data from the International Energy Agency (IEA), global oil and gas demand will continue to grow for decades. Covid-19 certainly has had an impact on our attitudes towards gas guzzlers. But there’s a lot of pent-up demand for them that will be unleashed once vaccines for the coronavirus are made available to everyone.
Employ a Wait-and-See Approach
It’s tough to argue against a stock that has returned 640% in 2020. And this quarter, 1 million fully electric and plug-in-hybrid vehicles may be sold worldwide.
However, Tesla remains overly dependent on the declining business of selling emissions credits. And it simply cannot sell enough cars to justify its current market capitalization, which is as much as the next six next most valuable global automakers — Toyota(NYSE:TM), Volkswagen (OTCMKTS:VLKAF), Daimler (OTCMKTS:DDAIF), General Motors (NYSE:GM), BMW and Honda (NYSE:HMC) — combined.
By all metrics, Tesla stock is overvalued at this stage. You wouldn’t want to be caught on the wrong side of this one when it plunges.