On October 25, 2021, the global capital market and even all of humankind ushered in a historic moment: Tesla’s stock price exceeded US$1,000 and the company’s market capitalization exceeded $1 trillion. Tesla, whose market capitalization just reached US$900 billion last Friday, saw its share price surge +12.66% on Monday (October 25), bringing its total equity market value to US$1.03 trillion. This means that Tesla has become a new member of the trillion-dollar club after Apple, Amazon, Google, and Microsoft. Elon Musk’s personal wealth also soared by 36 billion U.S. dollars in one day, now totalling nearly 289 billion U.S. dollars, making him the richest man in the world.
I believe that many people who bought Tesla shares are excited about this moment. However, let us really think about it. Is Tesla really worth one trillion U.S. dollars?
First of all, we need to clarify a concept in terms of corporate valuation: the market capitalization of a company usually consists of two parts – its current earning power and future earning potential, namely PVGO. PVGO is the abbreviation for Present Value of Growth Opportunities, which represents the growth value of a company. With that said, we can divide the value of a listed company’s stock into two parts, with one part coming from the present value of the cash flows generated by existing assets, and the other part coming from the value of future investments, that is, the value of growth opportunities.
A very simple corporate valuation formula related to this concept is:
Value of stock = (earnings/cost of equity) + PVGO
Existing earning power is usually relatively fixed, which is embodied in the current net profit rate of various businesses of a company. This is affected by factors such as production capacity, market conditions, and pricing, and will not have significant changes in the short term; PVGO is a more subjective estimate, and the volatility can be extreme. It is an estimate of the future earnings the company is generating potentially. The aggregate expression of this forward-looking mechanism is what we know well – the stock market.
So how do people’s investments in stocks significantly affect the company’s valuation?
In order to answer this question, a concept needs to be added – “herd behavior in the financial markets.” In the capital markets, the “herd behavior” refers to the behavior of a single investor in an investment group always acting in accordance with the actions of other investors of the same kind, such as buying when others buy and selling when others sell. The main factors leading to the “herd behavior” are information advantage, authority effect, and price stimulus. At the same time, the “herd behavior” may also be triggered by systemic mechanisms. For example, when asset prices suddenly fall and cause losses, some investors have to sell their assets in order to meet margin call requirements or to comply with trading rules. In this way, when there are small positive signals in the market, individual investors’ long positions will quickly accumulate, and they will be filled with confidence and aggressively chasing the rise; when the market dives, the panic psychology will start to take over in the form of a chain reaction and investors will flee one after another, which leads to dramatic changes in the stock price (i.e. the company’s market value).
In order to further reflect the subjectivity and huge volatility of PVGO, let’s take Rivian as an example. Rivian is an electric car company that has just completed the IPO process. Its stock soared +30% after its initial public offering a week ago, and as of November 11, its market value has exceeded US$100B. At this time, the market value of established car companies such as Ford is sitting around US$70B, and G.M. around US$90B. We found that the market capitalization of a freshly IPO’d company without any actual sales actually surpassed the values of these established auto companies in just one week. However, it is clear that Rivian is not comparable to Ford in terms of production capacity and market. The company’s background and operation are still insufficient. Its market value is almost entirely composed of PVGO, which is very unstable. It is foreseeable that Rivian’s market value will fall sharply in the near future. Sure enough, on November 17, Rivian’s stock price ended its week-long rally since the completion of the IPO. It fell by more than 18% within a day, wiping out billions of dollars in its market value since its IPO. From this example, it is not difficult to see that the crazy rise in Rivian’s stock price the previous week was just a bubble that was boosted up by the herd behavior in the market and eventually bursted.
This makes us think, will Tesla’s future be as bright as the current valuations? Or is it just like Rivian’s skyrocketing share price: a beautiful phantom before the bubble bursts?
According to two Wall Street banks, JP Morgan Chase and Barclays’ equity research reports on Tesla, Tesla’s stock may be significantly overvalued, which is also the view of many other Wall Street banks. It can be seen from the report that JP Morgan Chase believes that Tesla is worth US$250 per share, and Barclays believes that its stock price should be US$300. Both are well below Tesla’s current share price of US$1,033. In other words, from their perspectives, Tesla’s valuation is between US$250-300 billion. (Tesla’s total market value is now slightly more than US$1 trillion. JPMorgan Chase’s target price of US$250 per share implies a valuation of approximately US$250 billion, while Barclays US$300 implies a valuation of US$300 billion).
We can see that the skyrocketing of Tesla’s market value is mainly due to the increased expectations of the public for its future, and its own profitability has not risen much—that is, the company’s own stability. Its growth potential might not be substantial. Compared with other trillion-dollar companies such as Apple and Amazon, Tesla’s business model is not very well diversified, and its resistance to crises is relatively weaker (e.x. global inflation, epidemics, policy changes, etc.). The fall of New Oriental can be a cautionary tale when it comes to less diversified companies.
Regarding PVGO, we know that a significant factor for Tesla being highly valued is today’s increasingly severe environmental and energy problems, and the automotive transformation is indeed a targeted and tremendously large industry opportunity. However, Tesla is also facing the potential risk of price drops, such as the emergence of new energy rather than electric car companies (including nuclear energy vehicles, geomagnetic vehicles), the further development of infrastructure (such as ultra-efficient subways, etc.), and shared bicycles. Further development of services and breakthroughs in technology for efficient use of oil will bring Tesla’s market value down. Tesla’s future will never be smooth sailing.
In addition, as more and more companies gradually discover the opportunity in the electric vehicle market, competition in such markets will become increasingly fierce. Although Tesla is the leader in the electric vehicle industry, the participation of more and more competitors will still affect its bargaining power and production costs. At the same time, the company is also facing political considerations. Take China as an example: China now emphasizes sustainable development, and the complete transformation of electric vehicles is also on the agenda. At the same time, it is impossible for a country to give up all its market share to a foreign company because this is likely to damage the country’s economic security. It is foreseeable that the state will support a group of electric car companies to seize Tesla’s market and even replace the American EV (electric vehicle) juggernaut.
All in all, the irreplaceability of Tesla’s electric vehicles is not so strong. At present, Tesla’s future development potential is also limited, and it is not worth the sky-high valuation of one trillion U.S. dollars. We will examine Tesla’s valuation from a quantitative perspective in our next article.