Why Tesla Shares Still Face a Bumpy Ride

It's pretty much agreed that Tesla Motors is an innovative leader. The company's groundbreaking Model S electric-powered car looks like a well-engineered and quality product. The company's extreme market valuation is the only negative that naysayer's seem to offer. Though its lofty stock price could contribute to potential shareholder disappointment, the carmaker faces a hazard that might cause even greater investor suffering. Let's take a look at Tesla's biggest hurdle.

The problem's not the valuation, but the business model
While Tesla is clearly highly valued with a market cap at over six times sales, an extreme valuation doesn't necessarily pose a serious risk to an investor. Companies can go many years with what would be considered "overpriced" shares. Amazon.com, the Internet retailing giant, is a good example. A perennial highflier, its market worth is defended by huge top-line gains. Expected long-term growth is the key to justifying a towering valuation. That's the potential problem for Tesla. The company's business model is based on a premium-price product that would also need continually higher sales volume to justify its lofty market value. Maintaining the combination is an extremely difficult task.

Tesla's uptake numbers admittedly look good in its start-up phase. With over 19,000 Model S owners in more than 20 countries, the company had an impressive 5,500 deliveries in the latest quarter. Expanding internationally, delivering about 1,000 vehicles to European customers in the last reporting period, they have begun taking reservations in China. Total deliveries are expected to be at least 21,500 vehicles worldwide for 2013.

There are some cautionary signs, however. Tesla is now producing 550 cars per week but production in the quarter exceeded deliveries. The carmaker expects to deliver slightly under 6,000 Model S vehicles in the current quarter. Given planned production expansion, it seems that manufacturing will continue to surpass demand. The need to expand its market and push production might be an emergent sign of pressures building from a premium-priced, high-volume model. The company's need to increase recharging services, provide highly optioned Model S vehicles as service loaners, and offer a resale value guarantee may also be additional symptoms.

Competition will sap vital growth
Rising competition will stress Tesla's business model further. Each competing vehicle sold eliminates a buyer that could have provided the company needed growth. BMW successfully launched its first foray into the electric car space with the i3 model. Customers reserved more than 8,000 of this compact car even before the model was released and the i3 is just BMW's first shot. The company plans to expand the "i" series with a rechargeable i8 plug-in-hybrid sports car. The i8 is a performance-oriented car aimed at high-end buyers. The luxury electric-car market appears to be an attractive target; Porsche is advancing a 918 Spyder plug-in hybrid for the same crowd.

Tesla must also anticipate increased competition on the domestic front. General Motors assembled an internal task force to learn from Tesla's success. This group, called "Team Tesla" includes members from every aspect of GM's business. They have already tested the Tesla Model S and are expected to focus on deciphering the vehicle's technical advantages such as its low-cost battery pack and exceptional driving range. It's reasonable to assume that eventually GM will close the technology gap and produce a rival product.

When GM offers a viable competitor, its branding experience and marketing clout should help deliver noticeable sales. It can probably count on loyalists from the Cadillac brand, which sold about 50,000 vehicles in the last quarter, and Corvette enthusiasts, who purchased over 3,900 vehicles in October, to consider a GM premium electric car first. In addition, GM's dealership structure, with over 5,000 locations in North America and over 14,000 in Europe, Asia, and the Middle East, offers a wide net to snare others contemplating an electric-car purchase.

Conclusion
Tesla is a top-flight company with an innovative product but its stock market valuation depends on maintaining a difficult business model. Offering premium-priced products and continually maintaining high sales volumes is a feat that few businesses can accomplish.

Tesla shareholders may want to keep a vigilant eye on sales volumes. Any sizable deceleration in growth could raise similar questions about the company's ability to deliver on its premium-priced, high-volume business model. Growing doubts would likely severely affect Tesla's stock market value.

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The article Why Tesla Shares Still Face a Bumpy Ride originally appeared on Fool.com.

Bob Chandler has no position in any stocks mentioned. The Motley Fool recommends Apple, General Motors, and Tesla Motors. The Motley Fool owns shares of Apple and Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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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