I Can't Justify Tesla Motors' Valuation

I Can't Justify Tesla Motors' Valuation

Tesla Motors CEO Elon Musk thinks the company can produce 21,000 cars this year. Though this is certainly an impressive achievement, it pales in comparison with the 500,000-vehicle production rate Musk recently told Bloomberg he thinks Tesla can achieve at some unidentified point of time. Easier said than done. The scenario is definitely probable if Tesla really can introduce an electric vehicle in the $30,000 range, as Musk has suggested the company can do in as little as three to four years. Though it's a big what-if, it's fun to speculate exactly what kind of money the company could be earning if this scenario came to pass.

Fudging the numbers
Producing 500,000 cars per year, Tesla could earn about $880 million in operating income annually. That means at today's price, Tesla could be trading at just 15.7 times the company's earnings potential at a 500,000-car production rate. Comparatively, Ford trades at 10.6 times operating income.

I arrived at 880 million in operating income by making several assumptions:

  • Tesla sells 500,000 cars per year.

  • Tesla will eventually sustain a gross margin of at least 25%.

  • Zero-emission-vehicle credits will cease to benefit Tesla's top line.

  • Average selling price will decline to about $40,000.

  • Revenue from development services will grow in proportion to automotive sales.

  • Operating expenses will decline to 30% of revenue (still about three times higher than Ford's) as the company scales its operation.

Obviously, this model has been drastically simplified, and estimating something this far out into the future has very poor chances of being even close to correct. Even worse, I have no timetable for when Tesla could reach 500,000 cars annually. But the exercise does add some perspective.

Is it realistic?

Though Tesla may be able to attain a 25% gross profit martin by the end of 2013 on sales of the Model S, is it likely the company can sustain such an impressive gross profit margin when it starts selling a car in the $30,000 range? That's tough to say -- $30,000-$40,000 is a huge drop from the Model S prices ranging from about $70,000 to $80,000 and about $95,000 for the Model S performance

So taking things down a notch and estimating a 17% gross profit margin, close to Ford's first-quarter outcome, Tesla trades at just 25 times estimated 500,000-car production rate operating income.

Twenty-five times future operating income doesn't sound too bad for a growth stock, but there are just too many uncertainties involved in this math. When you find yourself fudging the numbers to estimate an outcome, projecting turns into pure speculation.

Projecting that Tesla can maintain 25% gross profit margins begins to seem like financial suicide when you consider the investment power at the disposal of some of the big names in the auto industry. As Fool contributor Daniel Miller recently said, "Those who think that Tesla is the future of the industry may be correct, but those same people often think that juggernauts like Ford, General Motors, and Toyota will simply roll over and die -- which I believe to be very foolish."

And how can we be certain Tesla will reach an annual production rate of 500,000 vehicles someday in the future, anyway?

At today's prices, Tesla stock is for speculators
Though I wouldn't sell shares of Tesla if I already owned them, I definitely wouldn't buy them today either. Sure, Tesla has a good chance of growing into a very large addressable market. But a significant portion of this opportunity is already priced into the stock. For now, I'll watch on the sidelines, and it won't bother me a bit if I miss out on big gains -- the risk isn't worth going for the home run.

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The article I Can't Justify Tesla Motors' Valuation originally appeared on Fool.com.

Fool contributor Daniel Sparks has no position in any stocks mentioned. The Motley Fool recommends General Motors and Tesla Motors and owns shares of Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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