The following is an excerpt from a forthcoming paper by ValueWalk guest contributor Dr. Brad Cornell. Dr. Cornell is a Professor at California Institute of Technology and is the mentor of Aswath Damodaran. Dr. Cornell and Aswath previously put together an academic study on Tesla Motors Inc. (NASDAQ:TSLA) valuation and they have just released a follow up piece on the topic. Also Dr. Cornell notes additional comments were made by Rob Arnott, John Haut, Jason Hsu, and May Huang (of Research Affiliates). Below is a brief interesting excerpt from the article which will be published in Journal of Portfolio Management.
In this respect, the Tesla situation has much in common with the Peso problem. As long as investors continue to believe that Mr. Musk will deliver a profitable mass market car in the foreseeable future, the stock price will be relatively impervious to negative short-term news, analogous to a fixed exchange rate. In fact, Mr. Musk’s repeated tweets, press releases and presentations are conceptually similar to central bank exchange rate support operations. Like such operations, however, at some point they will fail if they are not consistent with fundamentals. In the case of Tesla, whether Mr. Musk’s vision is consistent with fundamentals remains an open issue. Currently, the risk remains that some future quanta of negative news will set off a cascade of doubts regarding the fundamental resulting in a dramatic stock price decline akin to a “devaluation.”
In the meantime, as Veronesi (2004) notes, the risk of collapse is not captured fully by standard betas, because it is not reflected in the stock’s historical covariance with the systematic risk factors. Instead, risk measured from historical data reflects the interplay between Mr. Musk’s announcements and investor beliefs regarding the value of Tesla’s growth options. But that too will change when the fundamental operating profitability of Tesla is finally revealed.
Read the full paper here on SSRN.