Tesla Motors Inc (NASDAQ:TSLA) does have a real chance at becoming a major car company, but the stock price has gotten so out of line with reality that even the best-case scenario doesn’t lead to exceptional results for investors. Ford has a market cap four times that of Tesla, with about 100 times the sales. If it takes Tesla 15 years to grow its market capitalization to match Ford’s, investors will achieve an annualized return of 9.7% — that’s the best-case scenario. This is unlikely, as Tesla will probably become a niche player instead, in which case the return will be far lower or even negative. If everything goes right, buying Tesla Motors Inc (NASDAQ:TSLA) today will give you decent returns. Incredible risk, modest returns — that’s what Tesla offers today.
No barrier to entry
A lot of people use Pandora Media Inc (NYSE:P), an Internet music-streaming service, and it’s a great product. Pandora Media Inc (NYSE:P) pays out royalties each time it plays a song and generates advertising revenue from its free members and subscription revenue from its paying members. The problem is that there are a tremendous number of rivals, each offering essentially the same thing, and this will keep Pandora Media Inc (NYSE:P)’s profitability low or negative for the foreseeable future.
Spotify has become extremely popular, Apple is set to launch its own service, Google has an offering, and Windows 8 has a built-in music-streaming app. There are plenty of smaller competitors as well. There’s almost no barrier to entry in this business.
I don’t think that Pandora Media Inc (NYSE:P) makes sense as a stand-alone company. If it ever becomes consistently profitable, those profits will be low — far too low to justify the $3.6 billion market capitalization. There’s nothing truly unique about Pandora Media Inc (NYSE:P) to make it stand out from other services, and I’ve found most of them to be perfectly fine for my music-streaming needs. The owners of the content will always be the ones holding the cards, and the streaming services will always be at their mercy.
The bottom line
It’s not a bad idea to research companies that make your favorite products, but basing an investment decision solely on that product is a recipe for disaster. The three companies above have had their stocks bid up to elevated levels, likely by investors focused on the product instead of the business model, and eventually reality will catch up with them. A great product alone doesn’t make a great company, and too often this point is forgotten.
The article Great Products, Terrible Investments originally appeared on Fool.com and is written by Timothy Green.
Timothy Green has no position in any stocks mentioned. The Motley Fool recommends Pandora Media and Tesla Motors. The Motley Fool owns shares of Tesla Motors.
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