Tesla Stock: Big Potential, Bigger Risks, And Better Alternatives

Summary:

• Tesla, Inc.’s innovation and market opportunities are promising, but its high valuation and challenges pose significant for long-term investors.
• Tesla’s revenue diversification, especially with FSD, shows potential, but the company’s cyclical characteristics and macroeconomic sensitivity remain concerns.
• Valuation challenges arise from high market expectations, leading to a low margin of safety and potential downside risks.
• Better alternatives like Amazon and Google offer exposure to autonomous technology with more stable financials, making Tesla’s stock less attractive.

If you read my last analysis of Amazon.com, Inc. (AMZN), you’ll see that as a long-term investor, I value certain characteristics such as innovation, opportunities to explore new markets, and wide moats. Tesla, Inc. (NASDAQ:TSLA) is a company that has some of these characteristics: it’s very innovative, it’s been able to generate brand power in a competitive market, and it has good growth prospects by exploring new markets with high potential such as autonomous transportation with FSD/Cybercab and robotics with Optimus.

On the other hand, Tesla’s thesis is flawed in other ways. The main one is valuation. The market prices a practically perfect future for the company. These opportunities/optionalities, instead of being “extra” things in the thesis, end up being something that you need to consider to the extreme for the current market cap to make sense.

In addition, Tesla is still a cyclical company and very much affected by the macroeconomy and competition.

Tesla’s FSD Drive Growth Potential

Tesla’s main line of revenue is still automotive, but other lines such as energy generation and services began to appear more prominently a few quarters ago. In Q3 2024, these other revenue lines already represented just over 20% of total revenue. This means that Tesla’s revenue can gradually show better recurrence and also have a positive impact on margin, especially with the growth of full self-driving, or FSD.

Although this is now one of the main pillars of the thesis, a few years ago the vehicle sales number itself was one of the highlights. From 2020 onwards, the company managed to ride the interesting momentum and achieve gross margins of up to 27.1%. In relation to software companies this may seem low, but other automakers, such as Ford Motor Company (F), General Motors Company (GM), and BYD Company Limited (OTCPK:BYDDY), had gross margins of less than 15% in the same period. This highlighted some of Tesla’s positive factors, such as its great brand power (and consequently the desirability of its products and greater verticality) and also the company’s good efficiency.

These characteristics of a good business model are still concrete, but with the worsening macroeconomic scenario and a latent increase in competition, it has indicated that Tesla does have cyclical characteristics. This isn’t necessarily a bad thing, as many cyclical companies can be a good investment, but it’s still important to bear this in mind.

In the future, this cyclicality could be mitigated by changing its business model. The company is still very innovative and invests a lot in R&D, but much less than other companies that also aim to be or already reference in AI, robotics, and the like.

Coupled with investments in R&D, expertise in its field, and efficient management, Tesla is an innovative company capable of producing cutting-edge technology. Not long ago, the company announced Cybercab and Robovan, which could be one of the catalysts for the autonomous transportation industry, and also, together with FSD, be one of the main drivers of value generation for the shareholder.

Although not yet at full capacity, FSD and other similar Tesla technologies are credible. The company has already demonstrated its ability to do this and has been implementing and improving it over time. Version 13 of the FSD recently became available, making it a little easier to envision that the Cybercab could be produced in the medium term. Even so, there is a history of “failures” to achieve these goals before the stipulated deadline, making this more nebulous.

To sum up this section, for an equity investor, Tesla’s thesis is appealing. There is the possibility that the company really is part of the disruption of the automotive industry, being one of the main players in autonomous transport, as well as having already revolutionized the EV industry. Conversely, it’s undeniable that there is often hype surrounding the company, and it ends up affecting Tesla stock prices and forecasting.

Tesla Stock Valuation: Balancing Optimism and Risks

Making a valuation using realistic and pragmatic estimates for Tesla is ideal. This implies considering both possible optimistic and base scenarios where the company fails to deliver everything it promises.

The problem is that it is far from trivial to estimate the “full potential” of all of Tesla’s maturing initiatives. There are several variables that can be considered and which are practically impossible to estimate, such as the size of the addressable market, how much Tesla can capture from this market, what margin this business would have and the like. Not only that, but the market already incorporates relevant advances, which translate into a forward P/E of 136.3x. This multiple is much higher than that of innovative, high-growth companies that are known to be traded at a premium valuation, such as Amazon and NVIDIA Corporation (NVDA).

According to Goldman Sachs, Tesla could generate up to $75bn in revenue from FSD by 2030. In my opinion, this would be possible, but at the same time considering all this gain in sales is quite optimistic and greatly reduces the margin of safety of the thesis. Even so, let’s try to make some estimates.

Imagine that in some years (possibly around 2030), Tesla reaches a revenue of $180bn, with a record gross margin of 40%, and thereafter, about ~-10% of expenses, taxes, and others. This would be equivalent to a net income of $54bn. In this super-optimistic scenario, the price-to-earnings ratio would be ~25x. It’s true that it’s possible for the company to surpass these optimistic figures, but to consider them without many tangible facts is imprudent.

Trying to draw a reasonable but still optimistic scenario, with the assumptions in the table below, Tesla could reach a P/E of 35x by 2030, equivalent to an earnings yield of 2.8%. That’s considering a terminal 20% net income margin and reasonable sales growth.

In other words, as much as Tesla has the potential to revolutionize and add revenue beyond expectations with its initiatives, it is necessary to consider substantial advances for the valuation to make sense. This leads to a high level of corrosion of the margin of safety and also creates risks for the thesis. If Tesla fails to deliver what was promised in the time promised, there could be significant downsides, in addition to the opportunity cost.

Risks and Alternatives to Tesla Stock

One of the reasons Tesla’s stock has advanced a lot recently is Trump’s victory. This is mainly due to the expectation of more nationalistic policies that could positively affect the sale of Tesla cars while mitigating competition from the Chinese players.

The point of competition is still critical, and one of Tesla’s main risks. Chinese competitors like BYD have managed to achieve high efficiency, capture a lot of market share, and surpass Tesla in some metrics.

As Tesla’s market cap is quite high in relation to the financials it delivers, I believe the main risk is the execution of these future opportunities. As mentioned, there is a history of delays in promises made previously, and if the company fails to become a major player in autonomous transportation, the valuation is unlikely to make sense.

At the same time, I see that there are better alternatives for exposure to this industry. Amazon itself should be one of the main beneficiaries of robotics, and it also has an autonomous vehicles subsidiary, Zoox. Alphabet Inc. (GOOG), (GOOGL) is one of the leaders in this market through Waymo, and already operates robotaxis in cities such as Los Angeles and plans to expand to other cities such as Miami in the coming years. The most compelling thing is that these two do not depend on these initiatives, and already generate a lot of cash in relation to their market cap, unlike Tesla.

The Bottom Line

I’m bullish about Tesla’s initiatives. I believe that the company’s expertise together with its brand power will eventually succeed in increasing revenue and expanding margin, increasing value generation, and expanding into new markets. However, the valuation of Tesla stock is quite unattractive.

When I add to this very low margin of safety, with better alternatives, a stock that often behaves according to the hype, and other risks, I believe that the best rating according to a pragmatic analysis is “sell.” I aim for allocations with better risk-return ratios.

Better deliveries of promises or clearer scenarios where market share gains and possible cash generation occur through robotics with Optimus and especially autonomous driving with FSD and Cybercab, could change my mind and consequently turn this rating into a hold or buy.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of GOOGL, AMZN either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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