Why The Shine Has Come Off Tesla!

Oh, how the mighty have fallen! Many of you reading this are owners of Tesla’s (TSLA) stock. I know this because a whopping 42% of Tesla shareholders are retail investors, while institutional investors own 43%. This is in contrast to Ford (F) where institutional investors own 49% and in GM they own 80%. What this all mean is retail investors have MUCH more exposure to the ups and downs of Tesla’s stock. Up until this year Tesla’s stock mostly went up. From the stocks Covid low in March 2020 to its high November 2021, the stock was up an astounding 1400%. To put this in perspective, March 2020 to November 2021 covers 20 months, so that 1400% gain over those 20 months averaged a 70% gain PER MONTH! Remember, the general stock market only averages a 10% gain per year. So, the question now is, why has the stock plummeted this year? And is it a good buy going forward?

Elon Musk, Tesla’s CEO, recently tried to blamed the fall in the stock on the Fed raising interest rates which is causing car loan interest rates to rise. While this is true it only explains part of the reason for the stocks slide. The Fed raising interest rates is having a negative effect across the globe and on all industries but Tesla’s problems run deeper. First, Musk’s takeover of Twitter and subsequent right wing-leaning political rants on Twitter has turned off many would-be Tesla buyers. This was made evident by a recent survey that showed Tesla’s brand has taken a major hit since Musk’s Twitter takeover. But the more fundamental reason for the stocks slide, in my opinion, is simply valuation. In a rising interest rate environment stock valuations matter. After 14 years of being the only game in town the stock market now has competition for investors capital from the bond market. Investors can now get a decent return in the bond market with essentially no risk. Investors no longer have to go way out on the risk curve by investing in risking companies when they can park their money in bonds and sleep easy at night.

Tesla’s Insane Valuation

The price-to-earnings ratio (PE) is a way to measure a stocks valuation. The benchmark for PE valuations is that of the S&P 500. The lower the PE ratio is the better. A low PE implies a stocks value is low and potentially a good buy. At the height of the market, in November 2021, the S&P 500’s PE ratio was approximately 23, while Tesla’s was approximately 300!! I’ll say that again…Tesla’s PE ratio was ~300. So Tesla’s stock was trading at an eye-watering 1200% premium to the market. That insane valuation works when interest rates are close to zero and the cost to borrow money to buy stocks is, effectively, free. Also, as stated earlier, the stock market was the only game in town to earn solid returns. However, now that the Fed is raising rates aggressively and plans to keep rates high for a considerable amount of time, stocks with high valuations/PE ratios are completely out of favor on Wall Street. This dynamic, in my opinion, is the reason for Tesla’s dramatic 65% fall this year. The market is repricing what its willing to pay for risk and with the stock market down over 20% this year, we see the market is willing to pay MUCH less for risk in a rising interest rate environment.

Is Tesla a Good Buy

Long term, I believe Tesla is a good buy. There is a secular shift going on in the automotive industry. In many states and in some countries around the world, governments are mandating that new car sales are all EV’s. Also, millions of Millennials and Gen Z’s want to buy EV’s for environmental reasons. Currently, in the US, EV’s account for about 3% of cars on the road. The US automotive industry is worth over $100 billion annually so there is huge potential upside for Tesla in the years to come. Also, Tesla is profitable and has been growing its profits greatly. In July 2020, Tesla reported earning just 3 cents per share. In October of this year (2022), the company reported earning 95 cents per share. That’s a 3000% per share increase over just 1.5 years. Going forward, the company likely won’t grow its per share earnings by so much as other automakers are stepping up their EV divisions and sales. Tesla’s market share has come down recently from the high 70% range to the low 60% range. The companies market share will continue to fall but will remain the EV leader for years to come.