(The Motley Fool/John Bromels) – Nothing inspires heated debate among investors like Tesla (NASDAQ:TSLA). From its controversial CEO, Elon Musk; to the designs of its vehicles (seriously, what’s up with the Cybertruck?); to simple questions about its balance sheet — everyone seems to have a strong opinion about the world’s largest carmaker by market cap.
For now, let’s look at one of the most important questions for investors thinking of buying Tesla shares: Is Tesla overvalued? It sounds like a simple question, but there’s more to it than meets the eye.
Yes, it is
If you just look at Tesla’s raw numbers, it’s hard not to come to the conclusion that the company is way overvalued.
Let’s look at the most common valuation metric: the price-to-earnings ratio. For good measure, we can also check out the enterprise value-to-EBITDA ratio and the price-to-sales ratio. Here’s how Tesla compares with other major automakers, including No. 2 Toyota (NYSE:TM), General Motors (NYSE:GM), and luxury carmaker BMW (OTC:BAMXF):
One of these things is not like the others, am I right? Tesla’s valuation metrics are between eight and 23.6 times those of its nearest competitor by each metric (lower is better). That’s despite those other carmakers selling vastly more vehicles than Tesla does; even BMW, the smallest by market cap, delivered 675,680 cars in Q3 2020, nearly five times as many as Tesla’s 139,300.
Any way you slice it, Tesla looks obscenely overvalued.
No, it’s not
Tesla bulls don’t dispute that, compared to other automakers, Tesla’s valuation is insane. However, they argue, Tesla shouldn’t be compared to other automakers.
For one thing, Tesla’s sales are growing by leaps and bounds, and as those sales skyrocket, valuation metrics will come down. It’s not unusual for a fast-growing company to have a much higher valuation than an established player in a given industry.
Another common argument from Tesla bulls is that Tesla isn’t just any old automaker: it’s actually a tech company, so it should be evaluated against other tech companies. CEO Elon Musk clearly agrees. On Tesla’s Q3 2020 earnings call, Musk expressed his belief that “there’s in excess of a dozen start-ups effectively in Tesla,” including developers of microchips, battery cells, superchargers, and autonomous driving technology.
Certainly, when we compare Tesla’s price-to-sales ratio to some other hot stocks in the tech sector, its valuation looks much more reasonable:
The price-to-sales ratio is the only usable metric for comparison here because many of these companies, including Shopify, aren’t yet profitable. However, Tesla’s P/S ratio even compares favorably to fellow electric carmaker NIO and established graphics processor specialist NVIDIA (NASDAQ:NVDA).
Tesla is the largest of these companies, with a market cap of about $370 billion, but NVIDIA isn’t far behind, with a market cap of about $308 billion. However, by other valuation metrics, Tesla fares much worse against NVIDIA:
A higher P/E ratio makes sense for Tesla because it has vastly more depreciable assets than NVIDIA, but even going by the EV-to-EBITDA ratio, which strips out depreciation, NVIDIA sports a superior valuation. NVIDIA, though, has been around a lot longer than Tesla.
So, the question seems to be: is Tesla more like fast-growing start-ups Zoom Video Communications or Shopify, or more like established players NVIDIA or Toyota?
Time will tell
This isn’t an easy question to answer. Certainly, Tesla has an advantage over many of its competitors in the electric vehicle space in that it’s been manufacturing electric cars for a long time and thus has experience with the relevant technology, design challenges, supply chains, etc. It also may have a major leg up in terms of technology and patents.
However, competition in the space is about to get fierce, with new electric vehicle start-ups and established auto companies bringing a flood of battery-electric vehicles to market between 2021 and 2023. Other start-ups are focused on specific aspects of vehicle tech, like Hyliion’s electric drivetrains and Velodyne’s lidar technology for autonomous driving.
Tesla, though, has a wild card in the form of its non-automotive businesses, Solar Roof photovoltaic shingles and Powerwall and Megacell energy storage technology. Neither one is currently making significant contributions to Tesla’s bottom line, but each could be a significant source of profits down the road, depending on how things shake out.
Tesla’s clearly no bargain, and seems to be richly valued. Whether you think it’s overvalued depends on what kind of growth you expect to see in Tesla’s vehicle sales, its technological advances, and sales and development of the company’s non-vehicle products.
I tried to game out the likelihood of different growth scenarios and gave up; there are just too many variables in this fast-moving industry. However, Tesla’s growth potential probably earns it a higher valuation than a legacy car company. That said, a lot of growth seems to be priced into the stock, which has had a tendency not to move in tandem with the company’s fundamentals.
Bottom line: value investors should probably steer clear, and even growth investors should be aware that things may not go according to plan.