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Isn't Tesla stock highly undervalued?

by Liron2 min read18th May 202041 comments

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I'm asking this here because I'm by no means an expert on Tesla or stock picking. My only relevant skill is "order-of-magnitude perspective", a general ability to notice when a quantity seems to be out of whack by an order of magnitude.

Right now I'd guess there's a ballpark 50% chance that Tesla's market cap surpasses $1T by end of 2027, and 30% chance it surpasses $2T. Therefore my expected value for the stock price in 2027 is about $1T, or a 30%/yr return if purchased at today's $150B market cap.

Here's why I think Tesla is a clear pick to be one of the top 5 most valuable companies in the world within 10 years:

  • Their 5+ year lead in market-proven designs of electric cars, and of the factories that make those cars is, by itself, a really exciting thing to bet on
  • Their 5+ year lead in autonomous driving is, by itself, a really exciting thing to bet on
  • Their 5+ year lead in battery technology and manufacturing is, by itself, a really exciting thing to bet on. Even if they were to exit the car industry, they could earn $100B+/yr revenue making batteries for countless applications
  • Model 3 is the most popular electric vehicle in the world by far, and there's still plenty of room for quality improvement and price lowering.
  • Tesla is already profitable, yet are still many ways they can increase their gross margins, the most obvious of which is simply scaling up and optimizing everything further (they're the youngest major car company and have done this the least)

And here's why I think other investors are currently undervaluing it:

  • Most consumers still haven't considered buying a Tesla and are unaware of its key benefits such as safety, race-car-like acceleration, and rapidly increasing semi-autonomous driving capabilities. Even though Tesla stock is currently worth 2-3x more than the rest of the US car industry combined, it's still very much *not* a household name today (for neither consumers nor investors), compared to where it's about to be in 5 years or less.
  • Model 3 is still just an early version of what Tesla is capable of. Their Cybertruck, semi truck, and future sedans are going to be even bigger hits in the market.
  • Tesla is probably only a few months away from meeting the profitability requirements to be listed on the S&P, at which point a bunch of funds will automatically buy in and its stock will jump
  • This is just a guess, but I bet many investors don't realize how doomed the other car companies are right now. By 2025 at the latest, any Internal Combustion Engine car will not be competitive with any Tesla car on any dimension. Most/all other companies in the $4T/yr car industry have had engines as their core competency, and all the effort invested there now has zero long-term value. They are all investing somewhat in electric vehicles, but none at the "bet the company" level that was and is needed, due to the Innovator's Dilemma.

Finally, on a meta level, I get the sense that Tesla has a disjunction of many ways to win, many ways to turn into a positive black swan. Uncapped upside, similar to Bitcoin before its last few price surges (and plausibly still now). Normally investors get excited by a small fraction of the kind of signals that Tesla is showing. For example, I roughly doubled my money investing in Match Group because I was confident that usage of dating apps and spending on dating apps was going to increase significantly, and Match Group owns the most popular apps with the largest network effect. But that's nothing. The whole dating industry is a few $B. That's 1,000x smaller than the auto industry (not to mention batteries). Match Group also does not have 5+ year leads in any major technology sector. I'm sensing that Tesla is more obviously a great stock pick than what a good stock pick typically looks like.

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There are _LOTS_ of cases where an early leader got wrecked by some combination of established firms catching up (and surpassing) them, newer competitors understanding their market better than they, and a weird mix of consumer loyalty (to others) and fickleness (in terms of what they'll pay for).

5- and 10-year predictions of massive change are notorious for optimism bias. 20- and 30-year predictions tend to be too conservative. Your estimates fit this pattern - 50% chance to hit $1T in 7 years is at least an order of magnitude too high.

That said, Tesla is run by a mad genius, and does have a good indication that they're willing to bet big, so the outcomes are seriously bimodal. There _is_ a chance to see those big numbers. And a chance to completely implode. I have no objection to investments in TSLA, but I wouldn't put a significant portion of your bankroll into it.

The other major confounder between long-term predictions and stock picking is the pathing. TSLA is _not_ likely to be a slow, steady stock. It's going to have HUGE ups and downs, even if it does work it's way up to the levels you hope. So the question becomes "when". Market timing is silly and you shouldn't do it. But you're not betting on a market here, you're betting on an individual pathology of business and it's investors.

I agree with what you're saying. My point is that public stocks rarely can be said to have a startup-like "chance to see those big numbers" (10x+ upside). When such a chance is say 20%+, then you don't need to worry too much about the 80% chance of a 0.5x or 1x downside.

2Dagon1yI think you're overestimating at 20% as well. More importantly, you don't have any information that other investors don't, so it's hard to see that the full value of your prediction is available (some of it may be; the competing investors may be more short-sighted or conservative than they should be). As evidence for this, TSLA _already_ has a p/e around 200, compared to an automotive segment average around 20. So the first order of magnitude is already baked in. disclosure: I drive a Tesla Model S, which I love and am convinced it's the best car on the market at any price (superseded only by more recent model years). I work for and my investments are slightly overweighted toward un-vested stock (which I routinely sell for diversity as soon as possible, which makes me SIGNIFICANTLY poorer than the counterfactual me who just kept it all) a large tech company. Taking my financial advice is even dumber than investing based on high-level semi-random probability estimates based on an outside view of a complicated market.
Their 5+ year lead in market-proven designs of electric cars, and of the factories that make those cars is, by itself, a really exciting thing to bet on

They do have a lead, but I doubt that it's a five year one. BMW for one has a good electric car initiative going on, and the rest of the car industry is going that way too. I assume that all the major manufacturers have electric cars for sale by 2025, and they're much more able to ramp up production than Tesla is because of their existing factories. Just look at all Tesla's problems over the last few years ramping up by a factor of 5 over four years. To overtake the whole US market, they'd have to ramp up to ~20 million cars and light trucks/year, a factor of 200 more, plus you're imagining them selling to the rest of the world too. Frankly I think that's impossible for them. Becoming a major manufacturer is definitely plausible. Owning the entire market is impossible though.

Their 5+ year lead in autonomous driving is, by itself, a really exciting thing to bet on

Waymo (ie. Google) has a significant lead on Tesla, and would probably sell to all the other car manufacturers. Plus the last few years have shown that autonomous driving is very difficult to get to the truly valuable level. I'd give Tesla a <5% chance of getting to valuable levels (ie. level five autonomous driving) by 2025, and the chance of them beating the rest of the market there by a significant lead as <1%. P(beating market | valuable levels) = 20%

Their 5+ year lead in battery technology and manufacturing is, by itself, a really exciting thing to bet on. Even if they were to exit the car industry, they could earn $100B+/yr revenue making batteries for countless applications

That's their best bet I think, but the same difficulties with ramping up to that revenue remain. Plus they have the difficulties involved in running two largely separate businesses inside of one company.

Model 3 is the most popular electric vehicle in the world by far, and there's still plenty of room for quality improvement and price lowering.

This is basically the same point as your first one. The vehicle is exciting, but getting those price and quality improvements while ramping up production to high levels is very very difficult.

Tesla is already profitable, yet are still many ways they can increase their gross margins, the most obvious of which is simply scaling up and optimizing everything further (they're the youngest major car company and have done this the least)

Their margins are currently riding on not having significant competition, which is changing quickly and the rate of change is increasing. Electric cars are currently a luxury choice, thus having a high margin. But once you are trying to sell to the entire US market, prices are going to have to drop, and margins will drop with them.

As a final note, Tesla isn't going to do well in the short term, just like the rest of the car industry, since we're currently in a recession.

While I do think that Tesla can sell more than they currently are, the stock price already has that very factored in. Their market cap is $150B right now, which, assuming an insane $10k profit per car and a normal car manufacturer PE ratio of 10, shows sales of 1.5M cars/year, a 10x ramp up in car sales, again with an insane profit margin. Given that, clearly the market is already pricing in some significant gains.

I assume that all the major manufacturers have electric cars for sale by 2025, and they're much more able to ramp up production than Tesla is because of their existing factories.

It's not clear to me that it's easy to retool a factory from making ICE cars to making electric (w/ 2000 vs 20 moving parts in their drivetrains, respectively). Perhaps it's better than starting with nothing, but it's still going to be a huge cost.

Waymo (ie. Google) has a significant lead on Tesla, and would probably sell to all the other car manufacturers.
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I agree the market is pricing in a normal kind of expectation of “significant gains” but it’s not pricing in a major industry-changing “surprise” breakthrough announcement, which on the meta level should not be a surprise IMO, but rather the expectation. This company has ingredients in place for a massive upside. I admit I don’t know the facts here but I’m feeling pretty skeptical that BMW will have caught up to Tesla’s vehicles in 5 years or even shrunk the size of the lead, even given their currently much higher scale of car production capability.

Re auto

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4gbear6051yRe BMW, I just don't think that there's that much of a lead on Tesla's part. When I hear most consumers considering an electric car, BMW's i3 is a very competitive alternative to the Model 3, and I'd bet that the gap is going to shrink, especially in the price realm. I also hear about others [https://www.cnet.com/roadshow/news/every-electric-car-ev-range-audi-chevy-tesla/] , so Tesla definitely doesn't own the electric car space in consumer minds. Re autonomy, the problem is that 95+% of the value comes from the switch to not having to pay attention to the road. Until you get there, the autonomy is just another feature, not something that is going to get everyone to buy a Tesla. Up to that point, more autonomy can actually be dangerous since consumers will pay less attention to the road even when the car can't safely take over. I don't think that Tesla is really getting closer to that point, since that will probably need to have a change in method rather than just marginal improvements.
2Liron1yI think Tesla is pretty clearly making the best EVs right now but ya it’s hard to say how many years of lead they have and whether the lead is growing or shrinking. Why are you convinced that Waymo is ahead of Tesla on autonomy?
4ChristianKl1yWaymo has legal permits for driving fully driverless while Tesla doesn't. Waymo also invested a lot more years into building the tech then Tesla.
3gbear6051yFrom what I've heard online, Waymo has an approach to autonomy that seems more likely to lead to full autonomy than Tesla's incremental improvement approach. Waymo is using a wider array of sensors than Tesla, and it seems likely that Tesla's sensor array isn't enough to handle full autonomy. However, this is a weakly held belief since I only know things about it third hand, so on this specific issue I'm fairly neutral. That said, I think that everyone is far from the truly valuable autonomous car, so the value of the stock seems right (or too high) to me.
2Vaniver1ySpecifically, Musk doesn't think LiDAR will help [https://evannex.com/blogs/news/elon-musk-says-lidar-is-a-fool-s-errand-and-others-are-starting-to-agree] , and Waymo and others use it heavily, and from what I know of how this stuff works, the more sensors the better, for now. (I wouldn't be surprised if Musk turns out to be right in the long run, but also wouldn't be surprised if Tesla starts quietly adding LiDAR.)
2Liron1yIt seems like all the competitor EVs today have two major downsides vs Tesla: Huge price increase for same battery range ($20k or more) which I guess supports your point that Tesla's battery dominance is its main advantage, and the other EVs' autonomy features are very lacking. I also suspect that their overall car OS / software platform is lacking the design and integration that Tesla has.

FYI I agree with almost all of this, and currently have about 40% of my net worth in TSLA for that reason.

One caveat is the point about having a 5 year lead in autonomy -- they do seem to have a lead something like that for the cameras-only + collecting data from the fleet approach (though consider also comma.ai), but in terms of raw capabilities of the cars, it's not clear to me that they have much of a lead over Waymo / Cruise, etc, if any.

I think there's a reasonable argument that Tesla's approach is superior in the long run, but I wouldn't say they have a 5 year lead in autonomy full stop.

See also my Arbital claim from Dec, 2016, and my FB post from April, 2019.

Moved to answer, as it seems like clearly answering the question.

It is not very rational to have 40% of one's net worth in a single investment. You should use the https://en.wikipedia.org/wiki/Kelly_criterion to size your bets.

6ESRogs1yKelly should be applied to one's total wealth, including the value of future income (see: Lifecycle Investing [https://www.lesswrong.com/posts/4wL5rcS97rw58G98B/review-of-lifecycle-investing] ). Taking future income into account, my Tesla position is a smaller share of the total. Additionally, I want to target something like 2x leverage (Lifecycle Investing, again), so 40% of my net worth is only 20% of what I'd want to allocate to the market. That said, 40% might still be too much. I haven't rebalanced after the recent run-up, and I have a pending to-do to calculate my estimate of the expected returns and variance, and then adjust accordingly. I'm not sure which way that will come out.

One note regarding new engineering work: I believe Tesla hasn't patented its designs, meaning that its advantage is more in the area of having factories and supply chains for an essentially public design. Which it still has a first-mover advantage in, but it's not an intellectual property kind of advantage.

Their P/E ratio implies ~10x future company size already.

They just barely became profitable recently. I don't think P/E is super informative right now.

Like Amazon, they reinvest basically all of what they take in in growth, so don't end up with much in the way of profit. (Historically they've invested more than 100% of what they've taken in in growth, relying on selling equity. Recently it's started to be slightly less.)

So, I think you want to look at revenue, and project revenue growth and future gross margin to get the equivalent of a P/E ratio.

6romeostevensit1yGood point. I'm not familiar with TSLA, just poking at some sanity checks.
3sh4kesbeer10moI don't get how (re)investing should lower the profits? I mean they are buying assets and not burning the cash in the backyard. Are there instant depreciations on investments, lowering the profit?
2ESRogs10moHmm, good question. I actually don't have a good sense of how much of that is assets that remain on the balance sheet (e.g. manufacturing equipment) vs stuff like paying their employees to figure out how to make the batteries better, or how to set up the factory more efficiently. And paying employees to figure stuff out would show up as just costs on the balance sheet, rather than assets, unless you actually patented something, right? (I don't actually know accounting super well.) EDIT: It's intuitive to me though that when you're growing revenue at 50% annually (as Tesla has since 2013), you're just not going to be able to spend money as efficiently as when you're operating at, or close to, the same scale from one year to the next. (That is, efficiently in terms of short-term profit and loss. From a long-term perspective it might be very efficient, if the spending is enabling future growth.) I'm not sure exactly where that's most likely to show up on an accounting statement. But I do think it's what you'd expect by default. And it's how startups operate. You spend to grow, and you don't expect to be profitable right away. Tesla should perhaps be thought of as a rare public company that still operates like a high-growth startup.
2PeterMcCluskey9moBuying physical assets generally doesn't lower profits, but accountants don't have a good way to treat R&D, or investment in human capital, as investments.

I think they are likely to grow to 100x their current revenue - reasoning backward from market potential the way a startup investor does, rather than anchoring from their current size.

7gbear6051yI think the problem is the path to that 100x seems doubtful. They'd have to have 100x their current manufacturing, which is a very very difficult feat. Startup investors look at huge multiples like that because scaling a computer business is relatively easy. Making 100x the number of cars/battery sales involves (roughly) hiring 100x the number of employees, having 100x the number of factories, 100x the distribution work. Scaling that by 2027 is impractical even if that is their eventual trajectory goal. Meanwhile they're fighting in an increasingly competitive market.
4romeostevensit1ySo you expect them to be 2.5x Walmart's revenue? Which is the largest company by revenue in the world, in under 10 years?
4Liron1yOk 100x Tesla's 2019 gross revenue is a stretch (100 * $25B = $2.5T = half of car industry, 5x Walmart), I didn't think that through. For comparison, Toyota's market cap is $194B and their 2019 operating profit was $22B. Today the market is valuing Tesla at almost Toyota's level. I'll say there's at least a 20% chance that Tesla will surpass Walmart's revenue in 7 years, i.e. reach double Toyota's 2019 revenue. If Tesla can 5x their 2019 revenue (that's $125B), then they'll probably grow into their $150B market cap with a normal P/E ratio (I'm assuming higher margins than Toyota). So yeah, this seems like the consensus guess that the market is pricing in: Tesla keeps getting more powerful every year because it's building on a bunch of accumulated advantages, until it's one or two Toyotas, or it could somehow stumble and fire sale. But now, on top of that, we need to layer on the Elon Musk magic. Beyond 2025, Musk is just getting started. There are going to be "oh shit" moments where threads come together. It's like when SpaceX recently announced they're planning to start launching 1,000x more weight into space each year than all the rest of the world's companies combined (not to mention reusable rockets and Starlink). I can't invest in SpaceX, but I at least want to be holding tickets to the Elon Musk / Tesla show.
2romeostevensit1yIf spacex gets significantly larger than tsla then I can see Musk moving on to spending most of his time there and tsla slowing down on its rocket ship trajectory.

Your analysis includes many key points, and I quite like it. I don't think about this sort of thing very often alas, so I'd need to think a bunch more to come to a strong position on this. I'll record here one quick impression.

I expect there's something important here about the difficulty of innovation in the current world, which is partly a self-fulfilling prophecy, but also a true fact about how much of the world will behave toward Tesla. Like, this is the kind of engineering innovation that is not happening in most parts of the world, and you might bet on priors that something will also take out Tesla/Musk, like perhaps a major legal obstacle will mess them up really hard, even if you can't name it in advance.

For example, I think if the SEC had successfully gotten Elon Musk to stop being so open, honest and casual in public like on Twitter or in interviews, this would likely be severely damaging for Tesla's brand and marketing and sales. Musk is a far more visionary public figure than other impressive founders like Bezos and Zuckerberg, and there is an intense pressure on him to shut up and be quiet, which might just win out sometime.

Relatedly Tesla (and SpaceX) has had to make a lot of massively risky bets to get to this point, almost entirely running out of money many times, and I can imagine seeing many more of those in the future that mean you should assign a solid chance to just losing all of your money investing in them. My model of Tesla is that it's rarely "just chugging along", but mostly "trying to go hard on the risk-reward ratio at all times" in a way that looks unsustainable from the outside. Musk is never like "This will be a normal quarter" my impression is he's normally like "The entire future of the company depends on this quarter, so let's make sure we give it our all".

It seems that you have an assumption that customers will pay as much money for cars in ten years as they are doing now.

I think that's likely that driverless cars will result in less people owning cars and thus less cars needing to be produced.

luckily they also seem to be ahead of this trend by developing the driverless taxi fleet capability in their cars. it seems they're actively counting on and accelerating this trend.

cost of ownership will also go down commensurately since owners will be able to send out their cars to be used as autonomous taxis while not needed, thus earning money and offsetting the cost. potentially paying back the cost.

also given their position in grid level storage they have the ability to recycle the battery of the car for grid storage, thus lowering the long ter... (read more)

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You've created a list of reasons to like TSLA, but you haven't said a single thing that comments on the current valuation. If your current sentiment is already reflected in the price, you can be right about the future yet punished for being wrong about the valuation.

This is a lot of confidence for a very volatile stock.

Ya I’m now pretty convinced that Tesla’s market cap isn’t obviously off by an order of magnitude, and is merely a good buy with expected value similar to buying any top tech stock. So my accepted answer to the original question is “no”.

I endorse buying a significant amount (10%+) of top tech stocks and Tesla as part of a diversified personal portfolio.

Most investors are unaware that internal combustion engine cars are doomed. But I expect that they'll mostly be replaced by cheap electric cars from companies with little brand name recognition. Car use will continue to move to an Uber-like service model, where the car is a commodity. I'm betting on BYD, not Tesla.

I've now invested in NIO, mainly because it's a leader in fast battery swapping. Most likely other companies will eventually catch up in that area, but being first will give it a shot at being one of the frontrunners.

Is BYD able to achieve cheaper cost per kWh for their battery packs than Tesla?

Or do you expect Tesla to not be willing to sacrifice margins in the future in order to produce at high volume (contrary to the their stated plans)?

I'm guessing that no single company will dominate the battery market. I see some pro-Tesla hype, but little that would motivate me to pay 5 times sales for Tesla rather than 1 times sales for BYD.

So far the feedback in this thread has updated my opinion from "the rationalist community could conceivably agree that this is an amazing stock pick" to "this may be merely the usual kind of high-priced high-quality stock".

The point I haven't seen addressed in the comments is I think Tesla has unusually potent ingredients for a more than 10% chance of a 10x+ upside. Just scaling up its gigafactories and dominating battery production across all industries seems like a sufficient ingredient to tell a disjunction of such stories. Making an equity bet where the maximum loss is 1x therefore still seems attractive to me.

But you could probably say that about all the top 5 tech stocks, especially Amazon if I had to pick one. I do think it's currently good to own these tech stocks as a significant percentage of one's portfolio, and I guess owning Tesla may not be any better than that.

The point I haven't seen addressed in the comments is I think Tesla has unusually potent ingredients for a more than 10% chance of a 10x+ upside. Just scaling up its gigafactories and dominating battery production across all industries seems like a sufficient ingredient to tell a disjunction of such stories. 

IMO this is addressed by the "market is already pricing it at 10x growth" point. To unroll that, consider three cases: company grows to 100x, company grows to 10x, and company stays at 1x. In the world where those are the only options, pricing the stock at 10x its "stay the same size" value means that the 1x case is roughly 9 times more likely than the 100x case (and otherwise doesn't constrain things). Someone who thinks it's 10%/0%/90% should have the same EV as someone who thinks it's 5%/50%/45% or 0%/100%/0%.

Now, you can argue it's 10%/50%/40%, or whatever, and so it should be priced at 20x instead of 10x, but this is more in the "the usual kind of high-priced high-quality stock" territory.

Making an equity bet where the maximum loss is 1x therefore still seems attractive to me.

This also seems slightly off to me; all bets have a direct maximum loss of 1x, in some meaningful sense, and the "real loss" is going to be in the opportunity cost. That is, if I buy $10 of Amazon and you buy $10 of Tesla, and mine becomes worth $100 and yours becomes worth $1, we can look at this as you choosing to be $9 poorer or $99 poorer depending on where we put the baseline.

Their 5+ year lead in autonomous driving is, by itself, a really exciting thing to bet on

I"m not exactly how to assess this but probably worth mentioning that Buick, GM and Ford were conducting testing for self driving cars back in the early 1990s. To be sure, they were a lot different and how the entire system would need to come together to be successful is different.

However, it is also not clear, to me at least, that the best next generation small vehicle transportation system will simply be the same network of roads and control systems with "smart" cars. In other words, Tesla may well be a great stepping stone to the next level of transportation but not really where that is going and perhaps not even positioning it well for a better system/infrastructure setting.

Exciting yes but I think history has a pretty good number or first innovators that ended up getting sidelined for various reasons -- all I suspect relating to network type effects as they relate to the larger economic nexus in which they need to fit.