Tesla Stock Growth Options and Risk

Stewart Myers of MIT coined the term “growth options” to refer to future projects a company has the opportunity to undertake. Because the projects have not yet been undertaken, and in some cases may not yet be envisioned, the market valuation of growth options is prone to large swings. It depends on the perceptions of investors regarding what a company might be able to profitably do in the future. And those perceptions are likely to be mercurial because they are, by necessity, based on speculation regarding future businesses rather than the performance of actual businesses. Investor perceptions regarding the growth options of Tesla have been the reason that I have been wrong about Tesla’s stock price this year.

I thought it was overvalued at $300 because I did not see many growth options in the competitive automobile industry. There were enough investors that disagreed with me to drive the price over $380.

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What makes investing in companies whose value is derived in large part from growth options so risky is that perceptions can change much more rapidly than the economics of operating businesses. If perceptions do change, the market valuation of growth options can disappear virtually overnight. Again Tesla is an example. In a week, it has dropped from over $380 to about $335. (I still expect it to fall below $300). Of course, perceptions can change again if Mr. Musk makes some dramatic announcements. Such volatility is likely to continue until Tesla matures to the point where more of its value is based on actual operations.

About the Author

Prof. Bradford Cornell, Cornell Capital Group
Bradford Cornell is an emeritus Professor of Financial Economics at the Anderson School of Management at UCLA. Prof. Cornell has taught courses on Applied Corporate Finance, Investment Banking, and Corporate Valuation. He is currently developing a new course on Energy, Climate Change and Finance. Professor Cornell received his Masters degree in Statistics and his PhD in Financial Economics from Stanford University. In his academic capacity, Professor Cornell has published more than 125 articles on a wide variety of topics in applied finance, particularly empirical analysis of asset pricing models. He is also the author of Corporate Valuation: Tools for Effective Appraisal and Decision Making, published by Business One Irwin, The Equity Risk Premium and the Long-Run Future of the Stock Market, published by John Wiley and Conceptual Foundations of Investing published by John Wiley. He is a past Director and Vice-President of the Western Finance Association and a past Director of the American Finance Association. As a consultant, Professor Cornell has provided testimony and expert analysis in some of the largest and most widely publicized finance related cases in the United States. Among his clients are AT&T, Berkshire Hathaway, Bristol-Myers, Citigroup, Credit Suisse, General Motors, Goldman Sachs, Merck, Microsoft, Morgan Stanley, PG&E, Price Waterhouse, Verizon, Walt Disney and various agencies of the United States Government. Professor Cornell is also a senior advisor to Rayliant Global Investors and to the Cornell Capital Group. In both capacities, he provides advice on fundamental investment valuation. In his free time Prof. Cornell enjoys cycling and golf.