An Ode to Luck: Revisiting My Tesla Inc (TSLA) Valuation

When I bought Tesla Inc (NASDAQ: TSLA), I had no indication that it had hit bottom. In fact, given how strongly momentum and mood had shifted against the stock, I expected to lose money first, before any recovery would kick in, and I certainly did not expect a swift return on my investment. The market, of course, had its own plans for Tesla and the stock’s performance since the time I bought it is in the graph below:

One of my concerns, as an investor, is that I can sometimes mistake dumb luck for skill, but in this case, I  am operating under illusions. The timing on this investment was pure luck, but I am not complaining. What happened to cause the turnaround. There were three factors that fed into the upward spiral in the stock price:

1. Return to growth: In the middle of 2019, Tesla’s growth seemed to have run out of steam and there were some who believed that its best days were behind it. In the two quarters since, Tesla has shown signs of growth, albeit not at the breakneck pace that you saw it grow, earlier in its life.2. Operating improvements: One of Tesla’s weaknesses has been an inability to deliver on time and maintain anything resembling an efficient supply chain. In the second half of 2019, Tesla seemed to be paying attention to its weakest link, focusing on producing and delivering cars, without drama, and even running ahead of schedule on new capacity that it was adding in Shanghai.3. Radio Silence: I know that this will sound petty to Musk fans, but Elon Musk has always been a mixed blessing for the company. While his vision has been central to building the company, he has also made it a practice of creating diversions that take people’s attention away from the story line. He has also had a history of pre-empting operating decisions with rash missives (pricing the Tesla 3 at $35,000 and producing 5,000 cars/week) that led to operating and credibility problems for the company. Musk has been quieter and more focused of late, and the last six months have been blessedly free of distractions, allowing investors to focus on the Tesla story.

In earlier posts, I have drawn a distinction between the value of a stock and its price, noting that traders play the pricing game (trying to gauge momentum and shifts) and investors play the value game, where they invest based upon value, hoping for price convergence. While price and value are driven by different factors, in the case of Tesla, there is a feedback effect from price to value because of (a) its high debt obligations and (b) its need for more capital to fund its growth. As stock prices rise, the debt obligation becomes less onerous for two reasons. First, some of it is convertible debt, at high enough stock prices, it gets converted to equity. Second, Tesla’s capacity to raise new equity at high stock prices gives it a fall back that it can use, if it chooses to pay down debt. By the same token, the number of shares that Tesla will need to issue to cover its funding needs, as it grows, will decrease as the stock price rises, reducing their dilution effect on value.