A Do-It-Yourself (DIY) Valuation of Tesla Inc (TSLA): Of Investment Regrets and Disagreements!

To make your judgment on operating profitability, take a look at both the largest auto company tables and the one for FAANG stocks in the last section. There is not a single large auto company with double digit margins, and across all auto companies listed publicly, the profit picture is even more bleak:

The picture is brighter for the FAANG stocks, where the aggregate operating margin across all five stocks is 19.87%, well above auto industry averages. That margin, though, is delivered on smaller revenues and with business models where production costs are a smaller fraction of selling prices. The marginal cost of producing an extra unit for Microsoft is close to zero on both its Office and Cloud business, and even for Apple, which derives a large chunk of its revenues from the iPhone, the cost of making the iPhone is about about 40% of the price it charges.

This information should provide a basis for you to make a choice on a target operating margin for Tesla in the future, keeping in mind that its current operating margin is miniscule and barely positive.

As you make this choice, it is important that you tie it back to your earlier growth story. While Tesla sales of software/tech will have higher margins, it the auto sales that are responsible for the bulking up of revenues over time. Thus, if your argument is that Tesla will become predominantly a soft services company, you can give it higher margins, but your revenue expectations may have to be reduced. If you buy the argument of some that the costs of manufacturing will continue to drop (by about 15%), as production increases (doubles), you may think you have the basis for exploding margins, but the flaws in this argument should be obvious. First, there has to be a floor on cost savings or Volkswagen, which sells close to 10 million a year right now, should be making cars for close to nothing and generating margins of closer to 100% on the marginal car it sells (and it does not).

Second, even if there are revolutionary changes in technology that allow the costs of production to decrease, unless you can show that Tesla and Tesla alone can reap these benefits, you have a business that will see the prices drop, as costs drop. Put simply, if Wright’s law applies to all competitors, you and I will be able to buy electric cars at $3000/car and none of the manufacturers will be making sky high margins.

The investment efficiency lever is one of the trickiest to navigate. Again, the place to start is with automobile companies, and the table below presents the distribution of sales to invested capital across all auto firms, at the start of 2020.

Looking across global auto companies, the median company generates $1.37 in sales for every dollar of capital invested, and at the 75th percentile, the more capital-efficient auto companies generate $2.42 in revenues for every dollar of capital invested. In fact, my estimate of $3 in revenues for every dollar of capital invested reflects an optimistic view of Tesla’s capacity to bring technological innovation to its production processes, and reduce the capital needed to fund those processes. Since Tesla, in 2019, generates $1.32 in revenue for every dollar of capital invested, my estimate is more aspirational than based on observable efficiencies, right now.

Tesla Inc (NASDAQ: TSLA) bulls will counter with the tech company story, and to help the estimation process, I estimated the sales to invested capital at tech firms generally, just software firms and finally at just the FAANG stocks. None of these groups had sales to invested capital that were higher than my estimate. With that data to provide perspective, it is time to make your own judgment on investment efficiency:

This choice will drive not only how much Tesla will have to reinvest to grow, but the extent to which it will be dependent on external capital for that growth.