The surge of coronavirus brought turmoil in the stock market. Tesla rallied around 500% in the first eight months of 2020 but plunged about 30% in the early nine days of September.
Should You Buy Tesla (TSLA) Shares?
Tesla’s stock bulls generally claim that the company dominates the emerging global electric vehicle market and that comparing the stock and its valuation with traditional auto stocks is irrelevant. At the same time, Tesla Bears often point out that the stock’s valuation is too high, even when compared to fast-growing technology stocks, and Tesla will face an unprecedented wave of new competition over the next two years.
Doug Kass, chairman of hedge fund Seabreeze Partners Management, says he has opposed a short position in Tesla for years. However, with inventories surging more than 800% in the past 52 weeks, Kass says he could no longer sit on the sidelines. Kass finally pulled the trigger by exposing Tesla stock at the end of August for $ 2,014 in late August, representing a post-split price of around $ 403.
“It can now be argued that not only does Tesla’s stock represent a good short term, but at current prices, the stock could represent the largest single bubble – measured by a market cap of nearly $ 400 billion. – history,” Kass said.
But Tesla’s valuation is just one of several concerns he has about stocks.
Tesla’s Unproven Model
Tesla made another profit in the second quarter of 2020, but short-sellers like Kass are taking exception to how Tesla is generating income. Tesla reported a net income of $ 104 million for the quarter based on generally accepted accounting principles or GAAP. However, it also reported $ 428 million in regulatory credit sales in the quarter.
Tesla collects these legal credits to sell electric vehicles and sells many of these credits to other car manufacturers. These traditional automakers need the credits to avoid legal fines until they release their EV models. For now, Tesla can sell these credits for a 100% profit, but analysts say Tesla’s window of regulated credit sales window is closing.
Kass says that without regulatory credit sales, car sales are unprofitable.
“Adjusted for the sale of emission credits, Tesla has never been profitable in its 17 years of existence,” despite having no competition and no need for advertising, Kass says.
He is skeptical of Tesla’s valuation until it can prove that its automotive business can be significantly and consistently profitable.
Competition Is Tight
Another red flag for Tesla is that the company will face its first real wave of competition in electric vehicles in the next couple of years. In the first half of 2020, Tesla represented around 80% of the United States. Sales of electric cars, according to Loup Ventures. However, only 16 EV models are available in the United States, including five Tesla. By the end of 2021, competitors are expected to introduce another 20 EV models to challenge Tesla’s market share.
Kass says the first batch of new competitors comes from fresh, highly rated models from Polestar, Audi, and Volkswagen (VLKAF). Tesla was the first company to capture the electric vehicle market. But Kass says Tesla has a shallow competitive divide and no significant proprietary EV technology to set it apart from its competition, many of whom have a century of experience manufacturing and high-end marketing cars.
Priced for Perfection
Finally, Kass and many other Tesla short sellers are questioning of the stock’s valuation. Even after selling off nearly 30% in September from recent highs, Tesla stock is trading at an expected earnings multiple of 121 and a price-to-sell ratio of around 13.8. This valuation represents a substantial premium over former auto stocks Ford Motor Co. (F), General Motors Co. (GM), and Toyota Motor Corp. (TM), which on average, have a prepaid profit multiple of 10.3 and a price/sales ratio of 0.51.
“Faced with an onslaught of competition, Tesla’s market capitalization is now almost four times that of Ford, General Motors and Fiat Chrysler (FCAU) combined – despite selling only about (400,000) cars per year, against 17 million in sales for the big three units,” Kass says.
Tesla’s earnings fell nearly 5% in the last quarter, but many Tesla bulls say the automaker looks more like a high-growth technology stock than a car company. Unfortunately, valuation comparisons with large-cap tech stocks Apple (AAPL), Amazon (AMZN), and Microsoft Corp. (MSFT) is still considered overvalued. Tesla’s predicted earnings multiple is more than double the average of these technology giants, and the price-to-sell ratio is more than 50% higher.
While there is no doubt that Tesla has shaken up the global auto industry, its spiking share price has already resulted in significant long-term success. Tesla bears like Kass are skeptical that the company will ever be able to meet, let alone exceed, these sky-high expectations.