Rationalizing Tesla’s Stock Price

Rationalizing Tesla’s Stock Price
Continental at IAA 2015 Tesla S 1 01 from NewsMarket with permission

On Monday, June 1, 2020, Tesla‘s stock price rose $63.10 to close at $898.10. Given that Tesla has 185.37 million shares outstanding, this jump in price represented an increase in market capitalization of $11.7 billion.  To provide perspective, that number equals approximately 50% of Ford’s market capitalization.  That leads one to suspect there must have been some important good news either over the weekend or on Monday.  Unfortunately, most of the news filtering in was bad.  Electric car sales were down in China.  Tesla was cutting prices in the United States.  The deep recession was leading auto experts to predict lower future car sales.  This hardly seems like the sort of environment that can explain the stock price rising $63.10 from a price that Mr. Musk had said only a few weeks ago was already too high.

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But there was one important piece of good news, although it had nothing to do with the auto industry.  On Saturday, May 30, Musk’s other company, SpaceX, had a major success.  By successfully launching its new Crew Dragon spacecraft with astronauts on board for the first time, SpaceX became the first private company to launch astronauts for NASA. The test flight, called Demo-2, was also the first crewed launch to orbit from the United States since the space shuttle program ended in 2011.

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Rationalizing Tesla's Stock Price

Although the SpaceX launch had nothing to do with the auto industry, it did have something to say about Mr. Musk.  As I have noted in previous articles, rationalizing even Tesla’s price of $835.00 prior to the jump requires the assumption that the company is going to continue to be an innovation leader, grow dramatically and become one of the two or three top automobile companies in the world.  At the higher price of $898.10, it is all the same, even more so.

That is where SpaceX comes into play.  Its success says to the market the Musk is a genius and an innovator.  Investors might not be able to say exactly how that will translate into a dominant market position for Tesla, but such understanding is not required.  Investors are not betting on Tesla per se, but on Elon Musk, and the success of SpaceX underscores the market’s confidence in him.  If this guy can put rockets into space, how hard can it be to build better cars than Ford or GM?  What are those companies doing to keep up with this genius?

Needless to say, experiences such as the current stock price jump come with a warning for competing auto makers and investors who hold their stock.  One response to such events such as Monday’s jump in Tesla’s stock price is to “wait it out.”  Eventually, the market will realize the car business is highly competitive and capital intensive and as Tesla’s growth stalls its stock price will come back to earth.  But that viewpoint overlooks one key point.  Tesla’s sky-high stock price makes it possible for the company to raise equity capital on much more favorable terms than its competitors.  In effect, investors are willing to give Musk capital on terms they would not offer to any other automaker.  That makes it possible for Tesla to do things that its competitors cannot.  In effect, the belief in Musk becomes a self-fulfilling prophecy for Tesla.

Difficulty In Competing With Tesla

Unless competing auto makers respond in kind, it will becoming increasing difficult for them to compete with Tesla.  Somehow the competitors have to convince both investors and future car buyers that they have the talent and creativity to compete with Musk, even if they are not putting astronauts into orbit.  To date, they have been markedly deficient in that respect.  In terms of market capitalization, Tesla is now worth as much as Ford, GM, Fiat-Chrysler, Honda, BMW and Daimler-Benz, combined.

That suggests the competitors that have a lot of work to do to compete with the rocket man.  However, it does not mean that Tesla at current nosebleed prices is a reasonable investment.  Ultimately, the company has to produce and sell cars to generate cash flows and it is hard to see how the company can do enough of either to justify its current valuation.  The simple fact is that mass producing a reliable automobile at a consistent profit is incredibly difficult.  It does not have a great deal of wow factor.  To earn a fair return on an investment in Tesla at these levels, another rocket launch may required.

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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 Climate Change, Energy and Finance. Professor Cornell has published more than 125 articles and four books on a wide variety of topics in applied finance. Professor Cornell is also a managing director at BRG where he heads the practice on Climate Change, Energy and Finance. In addition, he is a senior advisor to the Cornell Capital Group and to Rayliant Global Advisors. In both capacities, he provides advice on fundamental investment valuation.
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