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.

[ Question ]

Isn't Tesla stock highly undervalued?

by Liron 2 min read18th May 202037 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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7 Answers

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.

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.

FYI I agree with almost all 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.

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

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.

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.