Is Tesla Motors Inc (TSLA) Valuation Getting out of Hand?

It’s about expectations
Tesla Motors Inc (NASDAQ:TSLA) will need far more than gross margin improvements to grow into its valuation. Fortunately, gross margin improvements are not the end of the story for Tesla. Last quarter alone the company’s sales increased by 83% from the prior quarter. Can sales growth and gross margin improvement combined save the stock from its valuation?

The average analyst estimate for Tesla Motors Inc (NASDAQ:TSLA)’s 2014 revenue is 2.32 billion. Assuming a gross margin of 25%, Tesla’s gross profit would equal 580 million in 2014. At today’s price, that means Tesla is trading at about 23 times its 2014 gross profit, assuming a 25% gross profit margin and 2.32 billion in revenue (146% higher than Tesla’s trailing-12-month revenue of 945 million). This is definitely a lofty expectation.

As Tesla’s stock continues to rise, I’m withdrawing my buy recommendation. Importantly, however, I don’t believe this means current investors should sell. I’m a big believer in holding onto companies as long as they are meeting or exceeding my original thesis — and Tesla hasn’t failed me on that front. In other words, I don’t sell good businesses (no matter the valuation), but I do consider valuation when I make an initial buy decision.

As price increases relative to the underlying fundamentals, risk increases too. Tesla is too expensive to buy, but as a business firing on all cylinders I wouldn’t sell it and pay taxes on my gain yet either.

Fool contributor Daniel Sparks has no position in any stocks mentioned. The Motley Fool recommends Ford Motor Company (NYSE:F) and Tesla Motors Inc (NASDAQ:TSLA). The Motley Fool owns shares of Ford and Tesla Motors Inc (NASDAQ:TSLA).

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